Is Cellnet Group Limited (ASX:CLT) Better Than Average At Deploying Capital?

Today we'll evaluate Cellnet Group Limited (ASX:CLT) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Cellnet Group:

0.04 = AU$993k ÷ (AU$47m - AU$23m) (Based on the trailing twelve months to June 2019.)

So, Cellnet Group has an ROCE of 4.0%.

View our latest analysis for Cellnet Group

Does Cellnet Group Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Cellnet Group's ROCE appears to be around the 4.0% average of the Electronic industry. Putting aside Cellnet Group'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.

Cellnet Group's current ROCE of 4.0% is lower than its ROCE in the past, which was 14%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Cellnet Group's ROCE compares to its industry.

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. You can check if Cellnet Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Cellnet Group's Current Liabilities Skew Its 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Cellnet Group has total liabilities of AU$23m and total assets of AU$47m. As a result, its current liabilities are equal to approximately 48% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Cellnet Group's ROCE is concerning.

Our Take On Cellnet Group's ROCE

So researching other companies may be a better use of your time. 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).

I will like Cellnet Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.