What Can We Learn From FW Thorpe Plc’s (LON:TFW) Investment Returns?

Simply Wall St

Today we are going to look at FW Thorpe Plc (LON:TFW) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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'.

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 FW Thorpe:

0.13 = UK£18m ÷ (UK£159m - UK£19m) (Based on the trailing twelve months to December 2019.)

Therefore, FW Thorpe has an ROCE of 13%.

Check out our latest analysis for FW Thorpe

Does FW Thorpe Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see FW Thorpe's ROCE is around the 13% average reported by the Electrical industry. Regardless of where FW Thorpe sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

You can see in the image below how FW Thorpe's ROCE compares to its industry. Click to see more on past growth.

AIM:TFW Past Revenue and Net Income March 31st 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for FW Thorpe.

What Are Current Liabilities, And How Do They Affect FW Thorpe's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

FW Thorpe has current liabilities of UK£19m and total assets of UK£159m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On FW Thorpe's ROCE

Overall, FW Thorpe has a decent ROCE and could be worthy of further research. FW Thorpe shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.