Today we are going to look at Livestock Improvement Corporation Limited (NZSE:LIC) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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. Generally speaking a higher ROCE is better. 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'.
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 Livestock Improvement:
0.067 = NZ$24m ÷ (NZ$425m - NZ$62m) (Based on the trailing twelve months to November 2019.)
Therefore, Livestock Improvement has an ROCE of 6.7%.
Does Livestock Improvement Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Livestock Improvement's ROCE is fairly close to the Food industry average of 8.2%. Aside from the industry comparison, Livestock Improvement'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.
In our analysis, Livestock Improvement's ROCE appears to be 6.7%, compared to 3 years ago, when its ROCE was 2.4%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Livestock Improvement's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Livestock Improvement is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Livestock Improvement's Current Liabilities Impact 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 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.
Livestock Improvement has total assets of NZ$425m and current liabilities of NZ$62m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Livestock Improvement's ROCE
That said, Livestock Improvement's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Livestock Improvement. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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