Why You Should Care About EssilorLuxottica Société anonyme’s (EPA:EL) Low Return On Capital
Today we’ll evaluate EssilorLuxottica Société anonyme (EPA:EL) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for EssilorLuxottica Société anonyme:
0.13 = €1.2b ÷ (€13b – €3.3b) (Based on the trailing twelve months to June 2018.)
So, EssilorLuxottica Société anonyme has an ROCE of 13%.
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Is EssilorLuxottica Société anonyme’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that EssilorLuxottica Société anonyme’s ROCE is fairly close to the Luxury industry average of 12%. Independently of how EssilorLuxottica Société anonyme compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for EssilorLuxottica Société anonyme.
How EssilorLuxottica Société anonyme’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
EssilorLuxottica Société anonyme has total assets of €13b and current liabilities of €3.3b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On EssilorLuxottica Société anonyme’s ROCE
This is good to see, and with a sound ROCE, EssilorLuxottica Société anonyme could be worth a closer look. You might be able to find a better buy than EssilorLuxottica Société anonyme. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
