Today we'll evaluate Leeds Group plc (LON:LDSG) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Leeds Group:
0.048 = UK£1.2m ÷ (UK£32m - UK£7.2m) (Based on the trailing twelve months to November 2018.)
So, Leeds Group has an ROCE of 4.8%.
View our latest analysis for Leeds Group
Is Leeds Group's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Leeds Group's ROCE is meaningfully below the Retail Distributors industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Leeds 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.
Leeds Group's current ROCE of 4.8% is lower than its ROCE in the past, which was 9.4%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Leeds Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. How cyclical is Leeds Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Leeds Group's Current Liabilities And Their Impact On 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.