Today we'll evaluate The Interpublic Group of Companies, Inc. (NYSE:IPG) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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'.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Interpublic Group of Companies:
0.12 = US$1.1b ÷ (US$17b - US$7.7b) (Based on the trailing twelve months to June 2019.)
So, Interpublic Group of Companies has an ROCE of 12%.
Does Interpublic Group of Companies Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Interpublic Group of Companies's ROCE is meaningfully better than the 9.0% average in the Media industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Interpublic Group of Companies's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Interpublic Group of Companies's current ROCE of 12% is lower than 3 years ago, when the company reported a 18% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Interpublic Group of Companies's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Interpublic Group of Companies's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Interpublic Group of Companies has total assets of US$17b and current liabilities of US$7.7b. Therefore its current liabilities are equivalent to approximately 47% of its total assets. Interpublic Group of Companies has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Interpublic Group of Companies's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Interpublic Group of Companies looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.