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Today we’ll evaluate Royal Mail plc (LON:RMG) to determine whether it could have potential as an investment idea. 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. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 Royal Mail:
0.10 = UK£545m ÷ (UK£7.4b – UK£2.0b) (Based on the trailing twelve months to March 2019.)
Therefore, Royal Mail has an ROCE of 10%.
See our latest analysis for Royal Mail
Is Royal Mail’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Royal Mail’s ROCE appears meaningfully below the 13% average reported by the Logistics industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Royal Mail compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Royal Mail.
What Are Current Liabilities, And How Do They Affect Royal Mail’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Royal Mail has total assets of UK£7.4b and current liabilities of UK£2.0b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Royal Mail’s ROCE
With that in mind, Royal Mail’s ROCE appears pretty good. There might be better investments than Royal Mail out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Royal Mail better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
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