Don’t Buy XLMedia PLC (LON:XLM) Until You Understand Its ROCE

Today we are going to look at XLMedia PLC (LON:XLM) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

How Do You Calculate Return On Capital Employed?

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 XLMedia:

0.19 = US$32m ÷ (US$200m - US$29m) (Based on the trailing twelve months to June 2019.)

So, XLMedia has an ROCE of 19%.

View our latest analysis for XLMedia

Does XLMedia Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. It appears that XLMedia's ROCE is fairly close to the Interactive Media and Services industry average of 17%. Independently of how XLMedia compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

XLMedia's current ROCE of 19% is lower than 3 years ago, when the company reported a 28% ROCE. So investors might consider if it has had issues recently. You can see in the image below how XLMedia's ROCE compares to its industry.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for XLMedia.

What Are Current Liabilities, And How Do They Affect XLMedia's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

XLMedia has total assets of US$200m and current liabilities of US$29m. As a result, its current liabilities are equal to approximately 15% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On XLMedia's ROCE

With that in mind, XLMedia's ROCE appears pretty good. There might be better investments than XLMedia 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.

XLMedia is not the only stock that insiders are buying. 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.