Today we are going to look at The Parkmead Group Plc (LON:PMG) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Parkmead Group:
0.061 = UK£4.6m ÷ (UK£82m – UK£6.1m) (Based on the trailing twelve months to June 2019.)
Therefore, Parkmead Group has an ROCE of 6.1%.
Is Parkmead Group’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Parkmead Group’s ROCE is meaningfully below the Oil and Gas industry average of 10%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Parkmead Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Parkmead Group delivered an ROCE of 6.1%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how Parkmead Group’s past growth compares to other companies.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Parkmead Group could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Parkmead Group.
What Are Current Liabilities, And How Do They Affect Parkmead Group’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.
Parkmead Group has total assets of UK£82m and current liabilities of UK£6.1m. As a result, its current liabilities are equal to approximately 7.4% of its total assets. Parkmead Group has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
The Bottom Line On Parkmead Group’s ROCE
Parkmead Group looks like an ok business, but on this analysis it is not at the top of our buy list. 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).
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 firstname.lastname@example.org. 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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