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Today we are going to look at Vesuvius plc (LON:VSVS) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. 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.’
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 Vesuvius:
0.091 = UK£145m ÷ (UK£2.1b – UK£398m) (Based on the trailing twelve months to June 2018.)
Therefore, Vesuvius has an ROCE of 9.1%.
Is Vesuvius’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Vesuvius’s ROCE appears meaningfully below the 13% average reported by the Machinery industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Vesuvius stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 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 Vesuvius.
What Are Current Liabilities, And How Do They Affect Vesuvius’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Vesuvius has total liabilities of UK£398m and total assets of UK£2.1b. 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.
Our Take On Vesuvius’s ROCE
That said, Vesuvius’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Vesuvius. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Vesuvius better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 email@example.com.