Today we are going to look at Tax-Net S.A. (WSE:TXN) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.
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 Tax-Net:
0.073 = zł366k ÷ (zł6.6m – zł1.6m) (Based on the trailing twelve months to March 2020.)
So, Tax-Net has an ROCE of 7.3%.
Is Tax-Net’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Tax-Net’s ROCE appears to be substantially greater than the 4.8% average in the Professional Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the industry comparison for now, Tax-Net’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
In our analysis, Tax-Net’s ROCE appears to be 7.3%, compared to 3 years ago, when its ROCE was 3.4%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Tax-Net’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Tax-Net? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Tax-Net’s Current Liabilities Impact 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Tax-Net has current liabilities of zł1.6m and total assets of zł6.6m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Tax-Net’s ROCE
If Tax-Net continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Tax-Net. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.