Today we’ll evaluate Cellnet Group Limited (ASX:CLT) to determine whether it could have potential as an investment idea. 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 up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In the end, ROCE 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’.
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 Cellnet Group:
0.18 = AU$3.8m ÷ (AU$29m – AU$8.1m) (Based on the trailing twelve months to June 2018.)
Therefore, Cellnet Group has an ROCE of 18%.
Does Cellnet Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Cellnet Group’s ROCE appears to be substantially greater than the 13% average in the Electronic industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Cellnet Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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, after all, simply a snap shot of a single year. How cyclical is Cellnet Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Cellnet Group’s Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cellnet Group has total liabilities of AU$8.1m and total assets of AU$29m. As a result, its current liabilities are equal to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Cellnet Group’s ROCE
This is good to see, and with a sound ROCE, Cellnet Group could be worth a closer look. Of course you might be able to find a better stock than Cellnet Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.