Today we'll look at Compagnie Financière Richemont SA (VTX:CFR) and reflect on its potential as an investment. 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Compagnie Financière Richemont:
0.089 = €1.9b ÷ (€28b - €6.3b) (Based on the trailing twelve months to March 2019.)
Therefore, Compagnie Financière Richemont has an ROCE of 8.9%.
Check out our latest analysis for Compagnie Financière Richemont
Does Compagnie Financière Richemont Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Compagnie Financière Richemont's ROCE appears to be around the 8.9% average of the Luxury industry. Separate from how Compagnie Financière Richemont 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.
Compagnie Financière Richemont's current ROCE of 8.9% is lower than 3 years ago, when the company reported a 13% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Compagnie Financière Richemont's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Compagnie Financière Richemont.
How Compagnie Financière Richemont's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.