Today we are going to look at Phoslock Environmental Technologies Limited (ASX:PET) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Phoslock Environmental Technologies:
0.12 = AU$3.6m ÷ (AU$38m - AU$7.7m) (Based on the trailing twelve months to December 2019.)
Therefore, Phoslock Environmental Technologies has an ROCE of 12%.
Does Phoslock Environmental Technologies Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Phoslock Environmental Technologies's ROCE is around the 12% average reported by the Commercial Services industry. Regardless of where Phoslock Environmental Technologies sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Phoslock Environmental Technologies has an ROCE of 12%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Phoslock Environmental Technologies's ROCE compares to its industry. Click to see more on 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. ROCE is only a point-in-time measure. If Phoslock Environmental Technologies is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Phoslock Environmental Technologies's Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Phoslock Environmental Technologies has current liabilities of AU$7.7m and total assets of AU$38m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Phoslock Environmental Technologies's ROCE
With that in mind, Phoslock Environmental Technologies's ROCE appears pretty good. Phoslock Environmental Technologies looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Phoslock Environmental Technologies better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. 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.
If you decide to trade Phoslock Environmental Technologies, use the lowest-cost* platform that is rated #1 Overall by Barron's, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.