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Today we'll evaluate CVS Group plc (LON:CVSG) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 CVS Group:
0.042 = UK£13m ÷ (UK£376m - UK£65m) (Based on the trailing twelve months to December 2018.)
So, CVS Group has an ROCE of 4.2%.
See our latest analysis for CVS Group
Is CVS Group's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see CVS Group's ROCE is meaningfully below the Healthcare industry average of 13%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how CVS Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. It is likely that there are more attractive prospects out there.
CVS Group's current ROCE of 4.2% is lower than 3 years ago, when the company reported a 7.6% ROCE. This makes us wonder if the business is facing new challenges.
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 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 CVS Group.