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Today we'll evaluate Yellow Pages Limited (TSE:Y) to determine whether it could have potential as an investment idea. 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. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Yellow Pages:
0.44 = CA$118m ÷ (CA$418m - CA$150m) (Based on the trailing twelve months to March 2019.)
So, Yellow Pages has an ROCE of 44%.
Is Yellow Pages's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Yellow Pages's ROCE appears to be substantially greater than the 8.8% average in the Interactive Media and Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Yellow Pages's ROCE currently appears to be excellent.
Our data shows that Yellow Pages currently has an ROCE of 44%, compared to its ROCE of 11% 3 years ago. This makes us wonder if the company is improving. The image below shows how Yellow Pages'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. 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 Yellow Pages.
How Yellow Pages'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 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.
Yellow Pages has total assets of CA$418m and current liabilities of CA$150m. As a result, its current liabilities are equal to approximately 36% of its total assets. Yellow Pages's ROCE is boosted somewhat by its middling amount of current liabilities.
What We Can Learn From Yellow Pages's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Yellow Pages shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.