U.S. Markets closed

Why You Should Care About Lookers plc’s (LON:LOOK) Low Return On Capital

Simply Wall St

Today we are going to look at Lookers plc (LON:LOOK) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Lookers:

0.098 = UK£64m ÷ (UK£1.9b - UK£1.2b) (Based on the trailing twelve months to December 2018.)

So, Lookers has an ROCE of 9.8%.

Check out our latest analysis for Lookers

Does Lookers Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Lookers's ROCE appears meaningfully below the 14% average reported by the Specialty Retail industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of where Lookers sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can see in the image below how Lookers's ROCE compares to its industry. Click to see more on past growth.

LSE:LOOK Past Revenue and Net Income, August 10th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Lookers.

How Lookers's Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

Lookers has total assets of UK£1.9b and current liabilities of UK£1.2b. Therefore its current liabilities are equivalent to approximately 65% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.

Our Take On Lookers's ROCE

The ROCE would not look as appealing if the company had fewer current liabilities. Lookers looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.