Here’s why Soprano Oyj’s (HEL:SOPRA) Returns On Capital Matters So Much

Today we'll evaluate Soprano Oyj (HEL:SOPRA) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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.'

How Do You Calculate Return On Capital Employed?

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 Soprano Oyj:

0.046 = €411k ÷ (€14m - €4.9m) (Based on the trailing twelve months to December 2018.)

Therefore, Soprano Oyj has an ROCE of 4.6%.

Check out our latest analysis for Soprano Oyj

Does Soprano Oyj Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Soprano Oyj's ROCE appears meaningfully below the 11% average reported by the Professional Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Soprano Oyj's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Soprano Oyj delivered an ROCE of 4.6%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Soprano Oyj is cyclical, it could make sense to check out this freegraph of past earnings, revenue and cash flow.

Do Soprano Oyj's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Soprano Oyj has total liabilities of €4.9m and total assets of €14m. As a result, its current liabilities are equal to approximately 35% of its total assets. Soprano Oyj's ROCE is improved somewhat by its moderate amount of current liabilities.

Our Take On Soprano Oyj's ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than Soprano Oyj. So you may wish to see this freecollection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this freelist of companies. (Hint: insiders have been buying them).

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.