Today we are going to look at InvoCare Limited (ASX:IVC) 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.
Firstly, 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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'.
How Do You Calculate Return On Capital Employed?
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 InvoCare:
0.064 = AU$89m ÷ (AU$1.5b - AU$144m) (Based on the trailing twelve months to June 2019.)
So, InvoCare has an ROCE of 6.4%.
Does InvoCare Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, InvoCare's ROCE appears to be significantly below the 9.2% average in the Consumer Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, InvoCare's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
InvoCare's current ROCE of 6.4% is lower than 3 years ago, when the company reported a 9.3% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how InvoCare's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
InvoCare's Current Liabilities And Their Impact On 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
InvoCare has total assets of AU$1.5b and current liabilities of AU$144m. Therefore its current liabilities are equivalent to approximately 9.4% of its total assets. With low levels of current liabilities, at least InvoCare's mediocre ROCE is not unduly boosted.
The Bottom Line On InvoCare's ROCE
If performance improves, then InvoCare may be an OK investment, especially at the right valuation. 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.
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 firstname.lastname@example.org. 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.