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Today we are going to look at Herkules S.A. (WSE:HRS) 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Herkules:
0.038 = zł12m ÷ (zł379m – zł72m) (Based on the trailing twelve months to March 2019.)
Therefore, Herkules has an ROCE of 3.8%.
Is Herkules’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Herkules’s ROCE is meaningfully below the Trade Distributors industry average of 8.8%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Herkules compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.9% available in government bonds. Readers may wish to look for more rewarding investments.
Herkules’s current ROCE of 3.8% is lower than 3 years ago, when the company reported a 6.4% ROCE. So investors might consider if it has had issues recently.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. ROCE is only a point-in-time measure. How cyclical is Herkules? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Herkules’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 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.
Herkules has total assets of zł379m and current liabilities of zł72m. Therefore its current liabilities are equivalent to approximately 19% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From Herkules’s ROCE
Herkules has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.
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.
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. Thank you for reading.