Yahoo Finance What Can We Make Of Spirax-Sarco Engineering plc’s (LON:SPX) High Return On Capital?
Today we are going to look at Spirax-Sarco Engineering plc (LON:SPX) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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. 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’.
How Do You Calculate Return On Capital Employed?
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 Spirax-Sarco Engineering:
0.27 = UK£351m ÷ (UK£1.6b – UK£253m) (Based on the trailing twelve months to December 2018.)
Therefore, Spirax-Sarco Engineering has an ROCE of 27%.
View our latest analysis for Spirax-Sarco Engineering
Does Spirax-Sarco Engineering Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Spirax-Sarco Engineering’s ROCE appears to be substantially greater than the 13% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Spirax-Sarco Engineering’s ROCE in absolute terms currently looks quite high.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Spirax-Sarco Engineering.
Spirax-Sarco Engineering’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Spirax-Sarco Engineering has total assets of UK£1.6b and current liabilities of UK£253m. As a result, its current liabilities are equal to approximately 16% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
Our Take On Spirax-Sarco Engineering’s ROCE
Low current liabilities and high ROCE is a good combination, making Spirax-Sarco Engineering look quite interesting. You might be able to find a better buy than Spirax-Sarco Engineering. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
