Discover our latest article on ROCE, a key indicator in the management of our funds BDL Rempart, BDL Convictions and BDL Transitions.
At BDL Capital Management, we have defined a number of key financial concepts that help us investing in good companies at the right price. Today, we are introducing ROCE (return on capital employed). It is the indicator that best captures the quality of a company.
A company finances itself through its shareholders and its banks.
It invests the funds it receives to develop its industrial base or to make acquisitions that strengthen its competitive position or accelerate its growth.
Shareholders calculate a company’s ROCE to check that their capital is being invested profitably.
This ratio measures the return the company generates on the capital entrusted to it.
The denominator of ROCE is the capital the company employs to operate. It consists of fixed assets and working capital. Fixed assets may include tangible assets, intangible assets and goodwill. Working capital corresponds to inventories and trade receivables, minus trade payables. This capital employed is what allows the company to operate and generate revenue and profits.
ROCE is obtained by relating these profits to capital employed.
Let us take the example of two companies, A and B, both of which have the same capital employed of €100 and respective ROCEs of 25% and 5%.
Thanks to its high ROCE, Company A generates €25 of profits, compared with only €5 for Company B. It therefore has far more opportunities for development. For example, if Company A uses €5 of its €25 of profits to fund 5% organic growth, it still has €20 left. If it then decides to spend €10 on acquisitions, it still has €10 remaining. It can use this to return capital to shareholders.
Company B does not have this luxury. If it also aims for 5% growth, it is forced to spend all of its profits. It has no money left for acquisitions or for shareholder distributions.
Although it is not widely used, ROCE is nevertheless a key indicator when analysing the quality of a company.
Experienced investors look for companies with a high and sustainable ROCE because they know that such companies create significant value for shareholders.
