Should You Worry About Spectris plc’s (LON:SXS) ROCE?

Simply Wall St

Today we are going to look at Spectris plc (LON:SXS) to see whether it might be an attractive investment prospect. 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. 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Spectris:

0.059 = UK£97m ÷ (UK£2.1b - UK£428m) (Based on the trailing twelve months to June 2019.)

Therefore, Spectris has an ROCE of 5.9%.

See our latest analysis for Spectris

Does Spectris Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Spectris's ROCE appears to be significantly below the 12% average in the Electronic industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Spectris's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

We can see that, Spectris currently has an ROCE of 5.9%, less than the 11% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Spectris's ROCE compares to its industry, and you can click it to see more detail on its past growth.

LSE:SXS Past Revenue and Net Income, November 7th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Spectris.

Spectris'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 counter this, investors can check if a company has high current liabilities relative to total assets.

Spectris has total liabilities of UK£428m and total assets of UK£2.1b. As a result, its current liabilities are equal to approximately 21% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

What We Can Learn From Spectris's ROCE

If Spectris continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Spectris. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.