Return on Capital Employed (ROCE) | Top Examples | Formula

Return on Capital Employed of Home Depot has grown phenomenally and currently stands at 46.20%. What does this mean for the company and how it impacts the decision-making process of the investors? How should we view return on capital employed (ROCE)?

In this article, we discuss in detail about how to compute ROCE and how relevant it is in terms of profitability of the company.

• Return on Capital Employed Definition?
• Return on Capital Employed Formula
• Interpretation of Return on Capital Employed (ROCE)
• Return on Capital Employed Examples
  • Return on Capital Employed- Example # 1
  • Return on Capital Employed- Example # 2
• Nestle – ROCE Example
• Home Depot ROCE Example
• Sector Return on Capital Employed
  • Return on Capital Employed – Utilities – Diversified
  • Return on Capital Employed – Beverages – Soft Drinks
  • Return on Capital Employed – Global Banks
  • Return on Capital Employed -Energy – E&P
  • Return on Capital Employed Internet and Content
  • Return on Capital Employed – Discount Stores
• Limitations of Return on Capital Employed (ROCE)
• Conclusion

Return on Capital Employed Definition?

Return on capital employed Definition – ROCE is a profitability ratio which tells how a company is using its capital. In simple terms, you can say that ROCE depicts company’s ability to efficiently utilize its capital. Return on capital employed is very useful from the perspectives of investors because from this ratio they get to decide whether this company would be good enough to invest into.

For example, if two companies have similar revenues but the different return on capital employed, the company which has higher ROCE would be better for investors to invest into. And the company which has lower ROCE should be checked for other ratios as well. As no single ratio can depict the entire picture of a company, it’s advisable that before investing into any company, every investor should go through multiple ratios to come into a concrete conclusion.

Also, look at this comprehensive Ratio Analysis Guide with excel case study on Colgate.

ROCE Video

Return on Capital Employed Formula

Let’s have a look at the Return on Capital Employed formula to have an understanding of how to calculate the profitability –

ROCE Ratio = Net Operating Income (EBIT) / (Total Assets – Current Liabilities)

There are so many factors we need to take into account. First, there is net operating income or EBIT (Earnings before interest and tax). Let’s talk about it first.

If you have an income statement in front of you, you would see that after deducting the cost of goods sold and operating expenses. Here’s how you should calculate Net Operating Income or EBIT –

	In US $
Revenue for the year	3,300,000
(-) COGS (Cost of Goods Sold)	(2,300,000)
Gross Revenue	1,000,000
(-) Direct Costs	(400,000)
Gross Margin (A)	600,000
Rent	100,000
(+) General & Administration Expenses	250,000
Total Expenses (B)	350,000

 

Operating Income before tax (EBIT) [(A) – (B)]

250,000

So if you have been given the income statement, it would be easy for you to find out net operating income or EBIT from the data using the above example.

Also, have a look at EBIT vs EBITDA

Now let’s look at the total assets and what we would include in the total assets.

We will include everything that is capable of yielding value for the owner for more than one year. That means we will include all fixed assets. At the same time, we will also include assets which can easily be converted into cash. That means we would be able to take current assets under total assets. And we will also include intangible assets that have value but they are non-physical in nature, like goodwill. We will not take fictitious assets (e.g. promotional expenses of a business, discount allowed on the issue of shares, the loss incurred on issue of debentures etc.) into account.

And as in the current liabilities, we will take into account the following.

Under current liabilities, the firms would include accounts payable, sales taxes payable, income taxes payable, interest payable, bank overdrafts, payroll taxes payable, customer deposits in advance, accrued expenses, short term loans, current maturities of long term debt etc.

Now capital employed doesn’t only include shareholders’ funds; rather it also includes debt from the financial institutions or banks and debenture holders. And that’s why the difference between total assets and current liabilities will give us the right figure of capital employed.

Interpretation of Return on Capital Employed (ROCE)

Return on capital employed is a great ratio to find out whether a company is truly profitable or not. If you compare between two or multiple companies there are few things you should keep in mind

• First, whether these companies are from similar industry. If they are from similar industry, it makes sense to compare; otherwise, the comparison doesn’t create any value.
• Second, you need to see the period during which the statements are made to find out whether you are comparing the companies during the same period.
• Third, find out the average ROCE of the industry to make sense of what you find.

If you take these three things into consideration, you can calculate ROCE and can decide whether to invest into the company or not. If ROCE is more, that’s better because that means the company has utilized its capital well.

• There is one more thing you should think about. You can use Net Income to come up with the ratio as well to get a holistic picture. The actual ratio is – EBIT / Capital Employed, but you can experiment by putting Net Income (PAT) / Capital Employed to see whether there is any difference or not.
• Moreover, you shouldn’t decide whether to invest into a company purely after calculating only one ratio; because one ratio can’t depict the whole picture. Compute all the profitability ratios and then decide whether this company is truly profitable or not.

Return on Capital Employed Examples

We will look at each of the items and then calculate the ROCE.

We take two Return on Capital Employed examples. First, we will take the simplest one and then we will show a bit complex example.

Return on Capital Employed- Example # 1

In US $	Company A	Company B
EBIT	30,000	40,000
Total Assets	300,000	400,000
Current Liabilities	15,000	20,000
ROCE	?	?

Now let’s calculate ROCE for both of these companies one by one.

We already have EBIT given, but we need to compute the difference between total assets and current liabilities to get the figure of capital employed.

In US $	Company A	Company B
Total Assets (A)	300,000	400,000
Current Liabilities (B)	15,000	20,000
Capital Employed (A – B)	285,000	380,000

Now let’s calculate the ROCE ratio for both of these companies –

In US $	Company A	Company B
EBIT (X)	30,000	40,000
Capital Employed (Y)	285,000	380,000
ROCE (X/Y)	10.53%	10.53%

From the above example, both of these companies have the same ROCE. But if they are from different industries, they can’t be compared. If they are from the similar industry, it can be said that they are performing quite similarly for the period.

Return on Capital Employed- Example # 2

In US $	Company A	Company B
Revenue	500,000	400,000
COGS	420,000	330,000
Operating Expenses	10,000	8,000
Total Assets	300,000	400,000
Current Liabilities	15,000	20,000
ROCE	?	?

Here we have all the data for computation of EBIT and Capital Employed. Let’s first calculate EBIT and then we will compute Capital Employed. Finally, by using both of these, we will ascertain ROCE for both of these companies.

Here’s the computation of EBIT –

In US $	Company A	Company B
Revenue	500,000	400,000
(-)COGS	(420,000)	(330,000)
Gross Revenue	80,000	70,000
(-)Operating Expenses	(10,000)	(8,000)
EBIT (Operating Profit) (M)	70,000	62,000

Let’s now calculate the Capital Employed –

In US $	Company A	Company B
Total Assets	300,000	400,000
(-)Current Liabilities	(15,000)	(20,000)
Capital Employed (N)	285,000	380,000

Let’s calculate Return on Capital Employed –

In US $	Company A	Company B
EBIT (Operating Profit) (M)	70,000	62,000
Capital Employed (N)	285,000	380,000
ROCE (M/N)	24.56%	16.32%

From the above example, it’s clear that Company A has higher ROCE than Company B. If Company A and Company B are from different industries, then the ratio is not comparable. But if they are from same industry, Company A is certainly utilizing its capital better than Company B.

Nestle – ROCE Example

Now let’s take an example from the global industry and find out ROCE from real data.

First, we will look at the income statement and balance sheet of Nestle for the period of 2014 and 2015 and then we will compute ROCE for each of the year.

Finally, we will analyse the ROCE ratio and would see the possible solutions Nestle can implement (if any).

Let’s get started.

Consolidated income statement for the year ended 31^st December, 2014 & 2015

source: Nestle Annual Report

Here three figures are important and all of them are highlighted. First is the Operating Profit for 2014 and 2015. And then the total assets and total current liabilities for 2014 and 2015 are needed to be considered.

Now, let’s compute ROCE ratio.

In millions of CHF
	2015	2014
Operating Profit (A)	12408	14019
Total assets	123992	133450
Total current liabilities	33321	32895

We know the EBIT or the operating profit. We need to calculate the capital employed –

In millions of CHF
	2015	2014
Total assets	123992	133450
(-)Total current liabilities	(33321)	(32895)
Capital Employed (B)	90,671	100,555

Now, let’s calculate ROCE.

In millions of CHF
	2015	2014
Operating Profit (A)	12408	14019
Capital Employed (B)	90,671	100,555
ROCE (A/B)	13.68%	13.94%

From the above computation, it’s clear that ROCE of Nestle is almost similar in both of the years. As in FMCG industry, the investments in assets are more, the ROCE is quite good. We should not compare the ROCE of FMCG industry with any other industry. In FMCG industry, capital investment is much higher than other industries, thus the ratio would be less than other industries.

Home Depot ROCE Example

Home Depot is a retail supplier of home improvement tools, construction products, and services. It operates in US, Canada and Mexico.

Let us look at the trend of Return on Capital Employed (ROCE) for Home Depot in the below chart –

source: ycharts

We note that Home Depot ROCE increased from ROCE of ~ 15% in FY10 to ROCE of 46.20% in FY17. What led to such a phenomenal growth in Return on Capital Employed for Home Depot?

Let us investigate and find out the reasons.

Just to refresh,

Return on Capital Employed Ratio = Net Operating Income (EBIT) / (Total Assets – Current Liabilities)

The denominator of (Total Assets – Current Liabilities) can also be written as (Shareholder’s Equity + Non-Current Liabilities)

ROCE can increases either because of 1) increase in EBIT 2) decrease in Equity 3) Decrease in Non-Current Liabilities.

#1) Increase in EBIT

Home Depot EBIT has increased from $4.8 billion in FY10 to $13.43 billion in FY17 (an increase of 180% over a 7 year period).

source: ycharts

EBIT increased the numerator significantly and is one of the most important contributors to the growth in ROCE.

#2 – Evaluating Shareholders Equity

Home Depot’s Shareholder’s Equity drastically declined from $18.89 billion in FY11 to $4.33 billion in FY17 (

We note that shareholder’s equity of Home Depot has decreased by 65% in the last 4 years. Declining shareholder’s equity has contributed to the decrease in the denominator of ROCE. With this, we note that the decrease in Shareholder’s Equity has also contributed meaningfully to the increase in Home Depot ROCE

source: ycharts

If we look at Home Depot’s Shareholder’s Equity section, we find the possible reasons for such a decrease.

1. Accumulated Other Comprehensive Loss has resulted in lowering of Shareholder’s equity in both 2015 and 2016.
2. Accelerated Buybacks were the second and most important reason for the decrease in Shareholder’s equity in 2015 and 2016.

#3 – EVALUATING HOME DEPOT DEBT

Let us now look at Home Depot’s Debt. We note that Home Depot debt increased from 9.682 billion in 2010 to $23.60 billion in 2016. This 143% increase in debt resulted in lowering of the ROCE.

source: ycharts

Summary of Home Depot ROCE

We note that Home Depot ROCE increased from ROCE of ~ 15% in FY10 to ROCE of 46.20% in FY17 because of the following –

1. EBIT increased by 180% over the 7 year period (2010-2017). It significantly increases ROCE due to increase in numerator
2. Shareholder Equity decreased by 77% in the corresponding period. This significantly reduces the denominator thereby increasing the ROCE.
3. Overall, increase in ROCE because of the two factors above (1 and 2) was offset by the 143% increase in debt during the corresponding period.

Sector Return on Capital Employed

Return on Capital Employed – Utilities – Diversified

Below is the list of top companies in Utilities Diversified Sector along with its Market Capitalization and ROCE

S. No	Name	Market Cap ($ mn)	ROCE
1	National Grid	51,551	5.84%
2	Dominion Energy	50,432	6.80%
3	Exelon	48,111	2.16%
4	Sempra Energy	28,841	6.08%
5	Public Service Enterprise	22,421	4.76%
6	Entergy	14,363	-1.70%
7	FirstEnergy	13,219	-19.82%
8	Huaneng Power	11,081	11.25%
9	Brookfield Infrastructure	10,314	5.14%
10	AES	7,869	5.19%
11	Black Hills	3,797	4.54%
12	NorthWestern	3,050	5.14%

• Overall, Utilities sector have a lower ROCE (in the range of 5%).
• Two companies in the group above have negative ROCE. Entergy has an RCOE of -1.70% and FirstEnergy has an ROCE of -19.82%
• The best company in this group is Huaneng Power with an ROCE of 11.25%.

Return on Capital Employed  – Beverages – Soft Drinks

Below is the list of top companies in Beverages in Soft Drinks Sector along with its Market Capitalization and ROCE

S. No	Name	Market Cap ($ mn)	ROCE
1	Coca-Cola	193,590	14.33%
2	PepsiCo	167,435	18.83%
3	Monster Beverage	29,129	24.54%
4	Dr Pepper Snapple Group	17,143	17.85%
5	National Beverage	4,156	45.17%
6	Embotelladora Andina	3,840	16.38%
7	Cott	1,972	2.48%

• Overall, the Beverages – Soft Drinks sector has better ROCE as compared to the Utilities sector with average ROCE at around 15-20%.
• We note that between PepsiCo and Coca-Cola, PepsiCo has a better ROCE of 18.83% as compared to Coca-Cola’s ROCE of 14.33%
• National Beverages has the highest ROCE of 45.17% in the group
• Cott, on the other hand, has the lowest ROCE of 2.48% in the group.

Return on Capital Employed – Global Banks

Below is the list of top Global banks with their Market Cap and ROCE

S. No	Name	Market Cap ($ mn)	ROCE
1	JPMorgan Chase	306,181	2.30%
2	Wells Fargo	269,355	2.23%
3	Bank of America	233,173	1.76%
4	Citigroup	175,906	2.02%
5	HSBC Holdings	176,434	0.85%
6	Banco Santander	96,098	2.71%
7	The Toronto-Dominion Bank	90,327	1.56%
8	Mitsubishi UFJ Financial	87,563	0.68%
9	Westpac Banking	77,362	3.41%
10	ING Groep	65,857	4.16%
11	UBS Group	59,426	1.29%
12	Sumitomo Mitsui Financial	53,934	1.19%

• We note that overall Banking Sector has one of the lowest ROCEs as compared to the other sectors with an average ROCE of 1.5%-2.0%
• JPMorgan, the largest Market Cap Bank has the ROCE of 2.30%
• ING has the highest ROCE of 4.16% in the group, whereas, Mitsubishi UFJ Financial has the lowest ROCE of 0.68%

Return on Capital Employed -Energy – E&P

Below list contains the Market Cap and ROCE of the top Energy Companies.

S. No	Name	Market Cap ($ mn)	ROCE
1	ConocoPhillips	56,152	-5.01%
2	EOG Resources	50,245	-4.85%
3	CNOOC	48,880	-0.22%
4	Occidental Petroleum	45,416	-1.99%
5	Canadian Natural	33,711	-1.21%
6	Pioneer Natural Resources	26,878	-5.26%
7	Anadarko Petroleum	25,837	-6.97%
8	Apache	18,185	-5.71%
9	Concho Resources	17,303	-18.24%
10	Devon Energy	16,554	-13.17%
11	Hess	13,826	-12.15%
12	Noble Energy	12,822	-6.89%

• Overall, Energy Sector ROCE looks pretty bad with negative ROCE with all top companies. This is primarily due to negative operating income resulting from slowdown of commodities (crudie oil)
• Concho Resources is the worst performing in this sector with an ROCE of -18.24%
• ConocoPhilips with the market cap of $56 billion has an ROCE of -5.01%

Return on Capital Employed Internet and Content

S. No	Name	Market Cap ($ mn)	ROCE
1	Alphabet	664,203	17.41%
2	Facebook	434,147	22.87%
3	Baidu	61,234	12.28%
4	JD.com	54,108	-6.59%
5	Altaba	50,382	-1.38%
6	NetEase	38,416	37.62%
7	Snap	20,045	-48.32%
8	Weibo	15,688	15.83%
9	Twitter	12,300	-5.58%
10	VeriSign	9,355	82.24%
11	Yandex	8,340	12.17%
12	IAC/InterActive	7,944	0.67%

• Overall, this sector has a mixed ROCE with very high and negative ROCEs
• Between Alphabet (Google) and Facebook, Facebook has a higher ROCE of 22.87% as compared to Alphabet’s ROCE of 17.41%
• Snap (that came out with its recent IPO) has a ROCE of -48.32%
• Other companies with negative ROCE are Twitter (-5.58%), Altaba (-1.38%), JD.com (-6.59%)
• Verisign has the highest ROCE of 82.24% is the group

Return on Capital Employed – Discount Stores

Below is the list of top Discount Stores with their Market Cap and ROCEs

S. No	Name	Market Cap ($ mn)	ROCE
1	Wal-Mart Stores	237,874	17.14%
2	Costco Wholesale	73,293	22.03%
3	Target	30,598	18.98%
4	Dollar General	19,229	22.54%
5	Dollar Tree Stores	16,585	12.44%
6	Burlington Stores	6,720	23.87%
7	Pricesmart	2,686	19.83%
8	Ollie’s Bargain Outlet	2,500	11.47%
9	Big Lots	2,117	26.37%

• Overall, discount store sector enjoys a healthy ROCE (average closer to 20%)
• Wal-Mart Stores with market cap of $237.8 billion has a ROCE of 17.14%. Costco on the other hand has a ROCE of 22.03%
• We note that Big Lots has the highest ROCE of 26.37% in the group, whereas, Ollie’s Bargain Outlet has the lowest ROCE of 11.47%

Limitations of Return on Capital Employed (ROCE)

There are a couple of disadvantages of ROCE.

• First, you can’t depend on ROCE alone because you need to calculate other profitability ratios to get the whole picture. Moreover, ROCE is calculated on EBIT and not on Net Income which can turn out to be a great disadvantage.
• Second, ROCE seems to favor older companies. Because older companies are able to depreciate their assets more than newer companies! And as a result, for older companies, ROCE becomes better.

Conclusion

In the final analysis, it can be said that ROCE is one of the best profitability ratios to consider while the investors decide upon the company’s profitability. But you need to keep in mind that ROCE is not the only profitability ratio to consider. You can also take into account several ratios like Profit Margins, Return on Invested Capital (ROIC), Return on Asset (ROA), Return on Equity (ROE) etc.

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