What is Return on Capital Employed (ROCE)?
Find out a company's capital efficiency
Whenever I come across a new investment idea, I always take a quick look at the last 5 years financial numbers. In addition to the basic numbers like revenue, operating and net profits, and cash flows I look at ratios like Return on Equity, Return on invested capital and Return on capital employed.
Return on Capital Employed (ROCE) is a profitability ratio. It measures how efficiently a company uses the available capital to generate its profits. ROCE is considered one of the best profitability ratios and is commonly used by investors to find out whether a company is investment worthy.
Calculate Return on Capital Employed
Earnings before interest and tax (EBIT) is the company’s profit, after accounting for all expenses except interest and tax expenses.
Capital employed is the total amount of capital (equity + long term debt) invested in a business. Capital employed is commonly calculated as either (total assets - current liabilities) or (fixed assets + working capital).
Some investors like to replace EBIT with Operating Profit.
Investors should always compare ROCE for companies within the same sector.
Examples
Lets compares two companies operating in the railway sector - Canadian National CNR 0.00%↑ and Canadian Pacific CP 0.00%↑.
Canadian National Railway (CNR)
For FY 2023:
Total assets = $52,666M and Total current liabilities = $5,035M. So, the capital employed = $47,631M
Operating Profit = $6,597M
ROCE = 6597/47631 * 100 = 13.85%
Canadian Pacific (CP)
For FY 2023:
Total assets = $79,902M and Total current liabilities = $5,710M. So, the capital employed = $74,192M
Operating Profit = $4,385M
ROCE = 4385/74192 * 100 = 5.91%
*All numbers sourced from StockRover.
Based on these ROCE numbers, CNR 0.00%↑ seems to be a better bet. But we should look at both companies in detail before making a final choice.
Why should investors use ROCE?
To measure a company’s capital efficiency and allocation
To identify and discard companies with inefficient capital allocation
To compare companies competing in the same sector
Why shouldn’t investors use ROCE alone?
It ignores the impact of capital structure
Historical ROCE numbers can show a general trend, but can’t predict the future
It can be manipulated as the calculation is based on profits and not actual cash flows
Summary
ROCE is a great tool to gauge a company’s capital efficiency
In addition to ROCE, investors should also use ratios like ROE, ROA, ROIC
Always compare the ROCE of companies within the same industry
I personally like to invest in companies with a minimum long term ROCE of 15%
Disclaimer: Please do not consider this post as an investment advice. I am not a registered financial advisor. Nothing in this article should be construed as an investment advice. Please consult a registered financial advisor before making any investment decisions.
Credits: Most of the content of this article is public information that can be found on news articles, government and company websites.