Why Tesmec S.p.A.’s (BIT:TES) Return On Capital Employed Might Be A Concern

Today we’ll look at Tesmec S.p.A. (BIT:TES) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we’ll go over how we 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.

What is Return On Capital Employed (ROCE)?

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. 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’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

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

Or for Tesmec:

0.033 = €3.9m ÷ (€294m – €173m) (Based on the trailing twelve months to June 2019.)

Therefore, Tesmec has an ROCE of 3.3%.

Check out our latest analysis for Tesmec

Is Tesmec’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Tesmec’s ROCE appears meaningfully below the 11% average reported by the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Tesmec stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

BIT:TES Past Revenue and Net Income, August 27th 2019
BIT:TES Past Revenue and Net Income, August 27th 2019

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 Tesmec.

Do Tesmec’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Tesmec has total liabilities of €173m and total assets of €294m. As a result, its current liabilities are equal to approximately 59% of its total assets. Current liabilities of this level result in a meaningful boost to Tesmec’s ROCE.

The Bottom Line On Tesmec’s ROCE

Tesmec’s ROCE in absolute terms is poor, and there are likely better investment prospects out there. You might be able to find a better investment than Tesmec. 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).

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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 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. Thank you for reading.