Today we'll look at Speedy Hire Plc (LON:SDY) 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.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Speedy Hire:
0.11 = UK£31m ÷ (UK£384m - UK£102m) (Based on the trailing twelve months to September 2018.)
Therefore, Speedy Hire has an ROCE of 11%.
Does Speedy Hire Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Speedy Hire's ROCE is meaningfully below the Trade Distributors industry average of 14%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of where Speedy Hire sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
As we can see, Speedy Hire currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 7.3%. 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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Speedy Hire's Current Liabilities Skew 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Speedy Hire has total liabilities of UK£102m and total assets of UK£384m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Speedy Hire's ROCE
This is good to see, and with a sound ROCE, Speedy Hire could be worth a closer look. Speedy Hire shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Speedy Hire better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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