Must-use financial ratios: Return on capital employed (ROCE)

Julie Brownlee, Fsp Invest, 20 Apr. 2015

Tags: return on capital employed, roce, financial ratio, investing, investing in shares, best financial ratio, finding good shares to invest in

When you look at shares to invest in, the profits a company generates are important. But you want to know how a company is making these profits work for its business.

One great financial ratio to use when looking at a company’s profits is return on capital employed. It can reveal a lot about a business and whether or not it’s worth investing in.

Read on to find out more about return on capital employed…

The ins and outs of return on capital employed

Return on capital employed (ROCE) is one of the most important financial ratios to use when deciding whether or not to invest in a share.

ROCE compares a company’s trading profit as a percentage of the money or assets it has invested in the business.

The simplest form of ROCE is:

ROCE = Earnings before interest and tax / capital employed

You can calculate the capital employed (or money invested in the business) by adding together the amount of equity raised and any loans the company has.

ROCE is all the money (or capital) a company is using (employing) to generate its profits (its return).

The ROCE you get is like an interest rate. The higher this figure, the better.

What does ROCE tells you?

ROCE tells you how good a company is at getting its money to work for it. And because it looks at all of the capital, it’s not just about what a company is doing with money from shareholders (equity).

Using ROCE can be more revealing that relying on profits alone.

This is because a company can flatter profits by doing things such as buying other companies or by making investments. Yet these uses don’t necessary make a company’s money work best as they may not generate high returns.

It’s best to calculate ROCE over a five year period and then look at the trend. If you uncover a company that shows a stable and high ROCE, it could indicate a very good company to invest in.

So there you have it, return on capital employed, a must-use financial ratio.

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