Today we’ll look at Pacific Smiles Group Limited (ASX:PSQ) and reflect on its potential as an investment. 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. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
How Do You Calculate Return On Capital Employed?
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 Pacific Smiles Group:
0.19 = AU$13m ÷ (AU$84m – AU$18m) (Based on the trailing twelve months to June 2019.)
So, Pacific Smiles Group has an ROCE of 19%.
Does Pacific Smiles Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Pacific Smiles Group’s ROCE is meaningfully better than the 10.0% average in the Healthcare industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Pacific Smiles Group’s ROCE currently appears to be excellent.
Pacific Smiles Group’s current ROCE of 19% is lower than 3 years ago, when the company reported a 26% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Pacific Smiles Group’s ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Pacific Smiles Group.
Do Pacific Smiles Group’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Pacific Smiles Group has current liabilities of AU$18m and total assets of AU$84m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Pacific Smiles Group’s ROCE
Low current liabilities and high ROCE is a good combination, making Pacific Smiles Group look quite interesting. Pacific Smiles Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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