Return on capital employed: A nifty way to weigh up a share before investing

Julie Brownlee, Fsp Invest, 11 Aug. 2014

Tags: return on capital employed, roce, what is roce, how to use roce, how to pick shares to invest in, fundamental analysis, investing

When it comes to finding good shares to invest in, it can be difficult to see how well a company is really performing. Looking at profits is a good start, but company profits are subject to some flattery.

So what’s a better way to look at the way a company’s performing? Calculate a company’s return on capital employed.

Read on to find out what you need to know…

What is ROCE?

Return on capital employed, or ROCE, is a great way to weigh up a company before you invest

ROCE looks at a company’s trading profit as a percentage of the money or assets it invests in the business.

In its easiest form, you add together the equity and borrowings of a company to get the money invested in the business.

The figure you get is like an interest rate, the team of experts at Money Week explain. So you’re looking for a high ROCE.

What does ROCE tell you?

ROCE tells you how good a company is at investing all of its money. So it takes into account shareholder equity and any borrowed funds.

It’s a way of measuring how hard the company has its money working for it.

Why is ROCE better than profits?

Profits can be misleading.

Companies can flatter their profits by buying other companies. Or by even investing their money. In this case, these investments aren’t always the best move for the company and may deliver poor returns.

How to use ROCE

If you want to use ROCE to weigh up a company, you want to calculate it for several years. Look at a minimum of five years and you’ll be able to see if there’s a trend.

If a company manages to maintain a high ROCE, it can be a sign of a very good company to invest in.

So there you have it, a nifty way to weigh up a share before investing.

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