Here’s why Elis SA’s (EPA:ELIS) Returns On Capital Matters So Much

Today we’ll evaluate Elis SA (EPA:ELIS) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared 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. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Elis:

0.045 = €294m ÷ (€7.8b – €1.2b) (Based on the trailing twelve months to December 2018.)

So, Elis has an ROCE of 4.5%.

Check out our latest analysis for Elis

Does Elis Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Elis’s ROCE is meaningfully below the Commercial Services industry average of 8.0%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Elis’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Elis’s current ROCE of 4.5% is lower than 3 years ago, when the company reported a 6.1% ROCE. This makes us wonder if the business is facing new challenges.

ENXTPA:ELIS Past Revenue and Net Income, April 29th 2019
ENXTPA:ELIS Past Revenue and Net Income, April 29th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Elis.

What Are Current Liabilities, And How Do They Affect Elis’s ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Elis has total liabilities of €1.2b and total assets of €7.8b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Elis’s ROCE

That said, Elis’s ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 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.