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Here's What Associated British Foods plc's (LON:ABF) ROCE Can Tell Us

Simply Wall St

Today we'll evaluate Associated British Foods plc (LON:ABF) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. 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. All else being equal, a better business will have a higher ROCE. 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 Associated British Foods:

0.12 = UK£1.3b ÷ (UK£14b - UK£3.1b) (Based on the trailing twelve months to September 2019.)

So, Associated British Foods has an ROCE of 12%.

Check out our latest analysis for Associated British Foods

Does Associated British Foods Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Associated British Foods's ROCE is meaningfully better than the 9.4% average in the Food industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Associated British Foods compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

The image below shows how Associated British Foods's ROCE compares to its industry, and you can click it to see more detail on its past growth.

LSE:ABF Past Revenue and Net Income, March 11th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Associated British Foods.

How Associated British Foods's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Associated British Foods has current liabilities of UK£3.1b and total assets of UK£14b. Therefore its current liabilities are equivalent to approximately 22% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On Associated British Foods's ROCE

Overall, Associated British Foods has a decent ROCE and could be worthy of further research. There might be better investments than Associated British Foods 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.