Are The Character Group plc’s (LON:CCT) High Returns Really That Great?

Today we'll look at The Character Group plc (LON:CCT) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. 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.'

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 Character Group:

0.37 = UK£13m ÷ (UK£57m - UK£22m) (Based on the trailing twelve months to February 2019.)

Therefore, Character Group has an ROCE of 37%.

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Does Character Group Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Character Group's ROCE is meaningfully better than the 13% average in the Leisure industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Character Group's ROCE in absolute terms currently looks quite high.

As we can see, Character Group currently has an ROCE of 37%, less than the 59% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

It is important to remember that ROCE shows past performance, and is 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Character Group's Current Liabilities Skew Its 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) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Character Group has total liabilities of UK£22m and total assets of UK£57m. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Character Group has a medium level of current liabilities, boosting its ROCE somewhat.

The Bottom Line On Character Group's ROCE

Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than Character Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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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.