In This Article:
Today we'll evaluate Foley Wines Limited (NZSE:FWL) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. 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'.
So, How Do We Calculate ROCE?
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 Foley Wines:
0.049 = NZ$8.5m ÷ (NZ$205m - NZ$30m) (Based on the trailing twelve months to December 2019.)
So, Foley Wines has an ROCE of 4.9%.
See our latest analysis for Foley Wines
Does Foley Wines Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Foley Wines's ROCE appears to be significantly below the 8.0% average in the Beverage industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Foley Wines's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
You can see in the image below how Foley Wines's ROCE compares to its industry. Click to see more on 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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Foley Wines? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Foley Wines's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.