CML Microsystems plc’s (LON:CML) Investment Returns Are Lagging Its Industry

Today we’ll look at CML Microsystems plc (LON:CML) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

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 CML Microsystems:

0.024 = UK£1.2m ÷ (UK£55m – UK£4.0m) (Based on the trailing twelve months to September 2019.)

So, CML Microsystems has an ROCE of 2.4%.

View our latest analysis for CML Microsystems

Is CML Microsystems’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, CML Microsystems’s ROCE appears to be significantly below the 11% average in the Semiconductor industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside CML Microsystems’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

CML Microsystems’s current ROCE of 2.4% is lower than 3 years ago, when the company reported a 8.1% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how CML Microsystems’s ROCE compares to its industry. Click to see more on past growth.

LSE:CML Past Revenue and Net Income, January 8th 2020
LSE:CML Past Revenue and Net Income, January 8th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

CML Microsystems’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

CML Microsystems has total liabilities of UK£4.0m and total assets of UK£55m. As a result, its current liabilities are equal to approximately 7.3% of its total assets. CML Microsystems has a low level of current liabilities, which have a negligible impact on its already low ROCE.

What We Can Learn From CML Microsystems’s ROCE

Nonetheless, there may be better places to invest your capital. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.