In This Article:
Today we’ll look at McPherson’s Limited (ASX:MCP) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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’.
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 McPherson’s:
0.22 = AU$22m ÷ (AU$156m – AU$56m) (Based on the trailing twelve months to June 2018.)
Therefore, McPherson’s has an ROCE of 22%.
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Does McPherson’s Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see McPherson’s’s ROCE is around the 26% average reported by the Consumer Durables industry. Putting aside its position relative to its industry for now, in absolute terms, McPherson’s’s ROCE is currently very good.
Our data shows that McPherson’s currently has an ROCE of 22%, compared to its ROCE of 8.9% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for McPherson’s.