Has James Latham plc (LON:LTHM) Been Employing Capital Shrewdly?

Today we are going to look at James Latham plc (LON:LTHM) 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.

Firstly, we’ll go over how we calculate ROCE. 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.

What is 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. 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.’

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 James Latham:

0.14 = UK£15m ÷ (UK£132m – UK£27m) (Based on the trailing twelve months to September 2018.)

Therefore, James Latham has an ROCE of 14%.

Check out our latest analysis for James Latham

Does James Latham Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see James Latham’s ROCE is around the 14% average reported by the Trade Distributors industry. Regardless of where James Latham sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

AIM:LTHM Past Revenue and Net Income, April 24th 2019
AIM:LTHM Past Revenue and Net Income, April 24th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is James Latham? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

James Latham’s Current Liabilities And Their Impact On 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 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.

James Latham has total assets of UK£132m and current liabilities of UK£27m. As a result, its current liabilities are equal to approximately 20% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On James Latham’s ROCE

With that in mind, James Latham’s ROCE appears pretty good. James Latham shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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.