Investing in a good company: ROCE

Watch our latest video explaining ROCE, a key indicator in our management of BDL Rempart, BDL Convictions, PEA funds, and BDL Transitions.

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At BDL Capital Management, we have defined a number of key financial concepts for investing in the right company at the right price. Today, we introduce you to the concept of ROCE (return on capital employed). It is the indicator that best summarizes the quality of a company.

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A company is financed by its shareholders and banks.

It invests the sums received to develop its industrial tool or make acquisitions to strengthen its competitive position or accelerate its growth.

Shareholders calculate the company's ROCE to verify that their money is being invested profitably.

This ratio measures the return the company gets on the capital it has been entrusted with. 

In the denominator of ROCE, we find the capital that the company uses to operate: it is made up of fixed assets and working capital requirements (WCR). Fixed assets can be tangible or intangible assets and also include goodwill. Working capital represents inventories and trade receivables less trade creditors. It is thanks to the Capital Employed that the company operates and makes sales and profits.  

These profits, related to the Capital Employed, give the ROCE.

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Let's take the example of two companies, A and B, which have the same capital employed of 100 euros and ROCEs of 25% and 5% respectively.  

Thanks to its high ROCE, company A has 25 euros of profit compared to only 5 euros for company B. It therefore has many more opportunities for development. For example, if company A uses 5 euros of its 25 euros of profits to aim for 5% organic growth, it still has 20 euros left. If it decides to spend 10 euros on acquisitions. It still has 10 euros left. It can use them to pay its shareholders.  

Company B does not have this luxury. If it too aims for 5% growth, it is forced to spend all of its profits. It has no money left for acquisitions or shareholder compensation. 

Although rarely used, ROCE is an essential indicator for analyzing the quality of a company.

The seasoned investor looks for companies with a high and sustainable ROCE because he knows they have a lot of shareholder value.

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