As per title. I hadn't really made use of it before, but a friend lent me a book from the guy who runs Fundsmith in the UK and he kept talking about ROCE.
Or is it only useful for stable or large companies that have been around a long time, rather than the growth stories?
I've been plugging in afew annual results and assuming no lazy effort or misunderstandings on my part in using the formula (though I'm happy to be corrected) I got (of the ones I had an initial go at).
PX1: 7%
HGH: 14%
ATM: 47%
GXH: 11%
QEX: 10%
OCA: -4% (this seems to be because they made a loss before tax)
For it to be truly effective it would have to be over more than one result though...
Looking at the above ATM looks really impressive (but looks abit like a falling knife at the moment), however I look at OCA which is one i see as a great long term play but the ROCE is less than flattering (and the previous year around 5% isn't that hot either).
If you're not a fan of ROCE, what's your favourite measures for assessing a company from their annual results?
Is ROCE a useful measure for assessing shares on the NZX?
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18-01-2021, 05:09 AMVesperIs ROCE a useful measure for assessing shares on the NZX?
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18-01-2021, 10:05 AMSnoopyHi Vesper and welcome to the forum. The first point I would make is that using only one tool to evaluate a company is dangerous. But as part of a suite of evaluation tools I would say ROCE or 'Return on Capital Employed' can be very useful, yes.Quote:
Originally Posted by Vesper
All measuring sticks work better with established companies. That is because fast growing companies are still evolving in their operational performance. So assuming last years ROCE is directly applicable to the current year may be a leap of faith. It is common for the ROCE of a growing company to be poor because they are often reinvesting all their cashflow to further develop the business. So just because the ROCE for a growth company is poor today, that isn't necessarily a pointer to the ROCE being poor in the future.
You are right to consider looking over more than one result. Myself I tend to look over a five year time frame. This is a compromise between gathering more data , say over 10 years, where those earlier years may not be reflective of the business as it is today. But at the other end of a compromise, if you just look at the last one or two years, those returns may not be reflective of an 'all of business cycle' operation.
You mention OCA, where a large slice of the profits come from capital growth of the underlying retirement village properties. This increases the company's capital which is good for shareholders. But perversely this will reduce the company's ROCE, when calculated from the EBIT and shareholder equity figures listed in the annual report. When a company increases capital via the dollar value increase of 'owned land and housing', I would take all such increases in value out of any ROCE calculation. That isn't an easy exercise. You would have to go back through all the annual reports and take out the profit growth due to increases in the property market. Then you would subtract all such profit growth from the shareholder equity before you performed your ROCE calculation. That would be a fair way to calculate comparative ROCE figures across different industries.
You are correct that the ROCE for A2 milk is impressive. You may also be aware of the current hiccup in earnings for this year. Looking at the big multi year picture this might be a buying opportunity. Or it might be the start of a longer term lower growth future. Such are the risks vs rewards of investing in growth shares.
The last issue I will complicate my reply with is that there is a 'value element' of any share purchase that is not reflected in ROCE. To use A2 milk as an example, and using round figures:
1/ If ROCE is 50% AND
2/ Shareholder equity is $2 per share AND
3/ the A2m share price is $10 THEN
4/ If you purchase A2 shares on market, that means the capital you buy shares at will be earning a ROCE of 50%/5 = 10%, not 50%, because you have to shell out $10 to buy just $2 worth of A2 milk equity ($10/$2=5, the divisor I used).
I hope that explains some of the the pitfalls of using ROCE alone a bit more. I don't want to put you off though because IMO it is a very useful tool.
SNOOPY -
18-01-2021, 05:45 PMpercy
I think Snoopy explained it very well.
One of the best indicators,but as Snoopy pointed out it is just one.
I tend to look at balance sheet strength,mainly current assets far exceeding current liabilities,and try to avoid loss makers.
I spend a lot of time on operational cash flow figures.Often this needs to take into a/c stock levels,and amount outstanding from customers and amount owing to suppliers.
For example PGW load up with stock in their first half,but get paid in their second half.ie Seasonal. -
19-01-2021, 08:43 AMVesper
Wow, that is an incredible welcome Snoopy (and thank you for your contribution as well percy!)
I have used three years normally for my timeframe of measures prior to giving ROCE a go. I kind of wish there was a website or Google Sheet where some diligent person (or bot) went through the NZX main board annual returns and plugged in the figures for easy reference (though as you've both rightly pointed out, one needs to consider more recent data outside of just the annual return including seasonal/macroeconomic factors depending on the industry and foreign exposure).
I've only ever seen the data in the PDFs attached on NZX - which isn't favourable to data extraction I have to say (I'm very fond of being able to pull the NZX main board as a table to easily refresh prices) - as someone from a non accounting background occasionally the financial statements of some of them make it trickier to be confident I'm using the right figure if I go too fast!
I absolutely agree that it should not be the only measure - I guess the main thing I wanted to try and work out is if it was its relevance to the NZ market and types of stocks and how good others considered it as a complementary measure. It seems you both think so, but with significant caution on using in conjunction with other measures.
The guy in the book tended to invest in long established companies (e.g. Colgate-Palmolive, Microsoft, Dominoes), whereas I suppose we don't have too many in the NZX with such a long vintage (well definitely HLG:)). Snoopy, the examples you've given on either end of the ROCE list I posted are a fascinating explanation - very, very helpful thank you. -
19-01-2021, 09:40 AMSnoopyPersonally I use ROEQuote:
Originally Posted by Vesper
Net Profit After Tax / Shareholder Equity
rather than ROCE
Earnings Before Interest and Tax / Shareholder Equity
This is because I can't control the amount of interest a company pays or the amount of tax it pays. So I invest on the basis of 'after tax returns'. A corporate can control the amount of interest they pay - at least theoretically- , by controlling their debt levels. If they have overseas subsidiaries they can, to an extent, control the amount of tax they pay too via transfer pricing.
ROCE is a better measure of 'underlying company efficiency', taking out the government tax effect and interest payments that could be extinguished if a deep pocket acquisitor bought the company.
SNOOPY -
19-01-2021, 10:07 AMwinner69
I prefer ROIC - Return on Invested Capital
Where the Return bit is EBIT - Tax (at company tax rate) and Invested Capital is both equity and debt (ie capital invested by shareholders and lenders)
ROIC then gives a return on all capital invested and hopefully is higher than the company's cost of capital
ROIC higher than cost of capital its adding economic value or if less than cost of capital its being value destructive
And hopefully ROIC will be higher than ROE - using debt as leverage to increase shareholder returns