Today we are going to look at Spirax-Sarco Engineering plc (LON:SPX) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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:
0.18 = UK£254m ÷ (UK£1.7b - UK£251m) (Based on the trailing twelve months to December 2019.)
So, Spirax-Sarco Engineering has an ROCE of 18%.
Does Spirax-Sarco Engineering Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Spirax-Sarco Engineering's ROCE is meaningfully higher than the 12% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Spirax-Sarco Engineering compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Spirax-Sarco Engineering's current ROCE of 18% is lower than 3 years ago, when the company reported a 25% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Spirax-Sarco Engineering's ROCE compares to its industry. Click to see more on past growth.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Spirax-Sarco Engineering.
What Are Current Liabilities, And How Do They Affect Spirax-Sarco Engineering's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Spirax-Sarco Engineering has current liabilities of UK£251m and total assets of UK£1.7b. As a result, its current liabilities are equal to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Spirax-Sarco Engineering's ROCE
With that in mind, Spirax-Sarco Engineering's ROCE appears pretty good. Spirax-Sarco Engineering 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.
There are plenty of other companies that have insiders buying up shares. You probably do 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 firstname.lastname@example.org. 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.