Today we are going to look at CPPGroup Plc (LON:CPP) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In the end, ROCE 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 CPPGroup:
0.21 = UK£4.7m ÷ (UK£49m - UK£31m) (Based on the trailing twelve months to June 2018.)
So, CPPGroup has an ROCE of 21%.
Does CPPGroup Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. CPPGroup's ROCE appears to be substantially greater than the 11% average in the Commercial Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, CPPGroup's ROCE is currently very good.
CPPGroup's current ROCE of 21% is lower than 3 years ago, when the company reported a 255% ROCE. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our freereport on analyst forecasts for CPPGroup.
What Are Current Liabilities, And How Do They Affect CPPGroup's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
CPPGroup has total liabilities of UK£31m and total assets of UK£49m. Therefore its current liabilities are equivalent to approximately 64% of its total assets.
The Bottom Line On CPPGroup's ROCE
While a high level of current liabilities boosts its ROCE, CPPGroup's returns are still very good. In my book, this business could be worthy of further research. I am always impressed by a high ROCE, but you also must consider other factors. One thing to consider is if insiders have bought shares recently.
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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 email@example.com.