Yahoo Finance Downer EDI Limited’s (ASX:DOW) Investment Returns Are Lagging Its Industry
Today we are going to look at Downer EDI Limited (ASX:DOW) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Downer EDI:
0.09 = AU$432m ÷ (AU$7.7b - AU$2.9b) (Based on the trailing twelve months to December 2018.)
Therefore, Downer EDI has an ROCE of 9.0%.
View our latest analysis for Downer EDI
Does Downer EDI Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Downer EDI's ROCE appears meaningfully below the 12% average reported by the Commercial Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Downer EDI's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 Downer EDI.
How Downer EDI's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Downer EDI has total assets of AU$7.7b and current liabilities of AU$2.9b. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Downer EDI has a medium level of current liabilities, which would boost its ROCE somewhat.
What We Can Learn From Downer EDI's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: Downer EDI may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
