Today we'll look at Webjet Limited (ASX:WEB) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Webjet:
0.099 = AU$90m ÷ (AU$1.5b - AU$617m) (Based on the trailing twelve months to June 2019.)
So, Webjet has an ROCE of 9.9%.
Is Webjet's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Webjet's ROCE is around the 9.9% average reported by the Online Retail industry. Aside from the industry comparison, Webjet's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that, Webjet currently has an ROCE of 9.9%, less than the 16% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Webjet's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Webjet.
How Webjet's Current Liabilities Impact Its 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.
Webjet has total liabilities of AU$617m and total assets of AU$1.5b. As a result, its current liabilities are equal to approximately 41% of its total assets. Webjet's ROCE is improved somewhat by its moderate amount of current liabilities.
What We Can Learn From Webjet's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better investment than Webjet. 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).
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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.