In This Article:
Today we'll look at John Wood Group PLC (LON:WG.) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
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'.
How Do You Calculate Return On Capital Employed?
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 John Wood Group:
0.043 = US$346m ÷ (US$12b - US$4.0b) (Based on the trailing twelve months to June 2019.)
Therefore, John Wood Group has an ROCE of 4.3%.
See our latest analysis for John Wood Group
Does John Wood Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, John Wood Group's ROCE appears meaningfully below the 7.3% average reported by the Energy Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how John Wood Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
John Wood Group's current ROCE of 4.3% is lower than its ROCE in the past, which was 8.0%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how John Wood Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Remember that most companies like John Wood Group are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.