Today we'll look at Vivo Energy plc (LON:VVO) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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 Vivo Energy:
0.18 = US$264m ÷ (US$3.2b - US$1.7b) (Based on the trailing twelve months to June 2019.)
Therefore, Vivo Energy has an ROCE of 18%.
Does Vivo Energy Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Vivo Energy's ROCE is meaningfully better than the 13% average in the Specialty Retail industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Vivo Energy's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Vivo Energy's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Vivo Energy.
How Vivo Energy'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.
Vivo Energy has total assets of US$3.2b and current liabilities of US$1.7b. Therefore its current liabilities are equivalent to approximately 53% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From Vivo Energy's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Vivo Energy 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.
I will like Vivo Energy better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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