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

Simply Wall St

Today we are going to look at RPS Group plc (LON:RPS) to see whether it might be an attractive investment prospect. 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. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

How Do You Calculate Return On Capital Employed?

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 RPS Group:

0.067 = UK£37m ÷ (UK£677m - UK£126m) (Based on the trailing twelve months to June 2019.)

So, RPS Group has an ROCE of 6.7%.

Check out our latest analysis for RPS Group

Does RPS Group Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see RPS Group's ROCE is meaningfully below the Commercial Services industry average of 10%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how RPS Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

You can click on the image below to see (in greater detail) how RPS Group's past growth compares to other companies.

LSE:RPS Past Revenue and Net Income, January 4th 2020

When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect RPS Group's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

RPS Group has total assets of UK£677m and current liabilities of UK£126m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From RPS Group's ROCE

That said, RPS Group's ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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

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.

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. Thank you for reading.