AsleepInYorkshire wrote:I have a vague idea what ROCE is. Return on capital employed.
I have always understood that high ROCE is good for a company. So when I look at financial information I am always keen to see a robust ROCE. That said I don't have a drop dead number.
Did you calculate it yourself or just use the number that the firm themselves give in their latest AR? Bear in mind that most firms will over egg their ROCE calcs.
I personally use (operating profit) / (capital employed). For capital employed I use Total Assets - Current Liabilities + Shortterm borrowings.
Recently I started looking at a small FTSE 250 company with a ROCE of 7-9%. Should I view this in isolation as a bad omen or is it part of the bigger picture?
It's part of the whole picture, albeit one of the larger parts. Ideally I try to go for at least 12-15% for several years of trading. The bigger the better!
Could it be (and the company seems to have plenty of cash) that the ROCE is low due simply to an abundance of cash?
A ha! That puts a slightly different spin on things. Then consider calculating the firms ROIC (return on invested capital). This is almost the same as the ROCE calculation except that the denominator is "Invested capital" = "Capital employed" - cash and equivalents - short term investments. Notice how this ratio removes the negative effect of all that cash that is not being utilised. Then I'd probably want to see ROIC a fair bit higher than ROCE.
However you need to ask yourself, why have they got this much cash? For example is it cos they have limited expansion opportunities, or is it because they actually need a lot of cash to keep buying raw materials which (perhaps) perish quickly? (but presumably they wouldn't need the cash cos if they are good they should have a decent credit arrangement with suppliers etc.)
A big consideration for you is "how much bigger is the ROCE compared to the company's cost of capital?". Because it is the difference in these figures that the leaves the company with room to pay it's owners back, or reinvest (without having to use debt).
Finally remember that if the company rents a lot of premises (typically for retailers) then you should do a separate ROCE calculation using Capital Employed adjusted for lease/costs. IIRC in the case of WHSmith this more than halves their ROCE figure.
Hope this helps
Matt