Accountants: guidance please - ROCE

[lockhart flawse]

Is there any ballpark figure as to what constitutes a good return on capital employed? I am aware that it has to be greater than the cost of borrowing and I assume the minimum figure would be the return from putting the working capital etc in the post-office or wherever (say 2.5%) but if an enterprise is generating 45% ROCE - how does that compare to most businesses - good, average, poor?

Grateful for any guidance.

[Eric Mc]

The vast bulk of businesses pay almost no attention to such ratios - if that's any consolation.

[4lf4-155]

Massively broad question - industry comparisons would be the first place to look.

But as Eric says unless you're a listed company very few people will actually take any notice.

[4lf4-155]

Massively broad question - industry comparisons would be the first place to look.

But as Eric says unless you're a listed company very few people will actually take any notice.

[walm]

I am not an accountant but as an investor I pay very close attention to ROCE.
45% (post-tax) would be extremely high for most businesses that I look at, but then they are usually very well established.
Smaller more volatile businesses might well have 45%+ in one year and negative the next etc...
For me the medium-term sustainable ROCE is most important.

The reason it is important is because combining it with the anticipated growth rate tells me what multiple of earnings is appropriate to pay when I value the business.

In theory, you can't generate a ROCE much above your WACC for very long unless you operate in a monopoly or regulated market.
The reason for that is because returns>WACC are considered "excess" and should be eroded by new market entrants or product/service substitutes or other players in the value chain (such as customers or suppliers) demanding their share of the excess profits etc...

However, if the business has good barriers to entry then you can often enjoy excess returns for some time which makes it a very valuable business.

[Adam B]

lockhart flawse said:

Is there any ballpark figure as to what constitutes a good return on capital employed? I am aware that it has to be greater than the cost of borrowing and I assume the minimum figure would be the return from putting the working capital etc in the post-office or wherever (say 2.5%) but if an enterprise is generating 45% ROCE - how does that compare to most businesses - good, average, poor?

Grateful for any guidance.

45% is bloody high for a mature business, if this typical and not a one off - what industry?

[lockhart flawse]

Thanks for the help. Reasonably typical return. Old fashioned branded business in food sector with no likely new entrants and it's a niche within a niche.

[Adam B]

lockhart flawse said:

Thanks for the help. Reasonably typical return. Old fashioned branded business in food sector with no likely new entrants and it's a niche within a niche.

if high barriers to entry and reasonable supplier power (ie not vulnerable to retailer bullying) then invest, then give me their name I will invest too



this does not constitute advice, caveat emptor, prices go down as well as up, past performance is no guarantee of future performance, your house may be at risk if you do not keep up repayments - think that covers it

Edited by Adam B on Thursday 29th May 12:28