Today we’ll evaluate Huntsworth plc (LON:HNT) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. 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.’
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Huntsworth:
0.11 = UK£24m ÷ (UK£304m – UK£81m) (Based on the trailing twelve months to June 2018.)
So, Huntsworth has an ROCE of 11%.
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Is Huntsworth’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Huntsworth’s ROCE appears to be around the 9.0% average of the Media industry. Separate from Huntsworth’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Huntsworth’s ROCE appears to be 11%, compared to 3 years ago, when its ROCE was 8.0%. This makes us think about whether the company has been reinvesting shrewdly.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Huntsworth.
What Are Current Liabilities, And How Do They Affect Huntsworth’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Huntsworth has total assets of UK£304m and current liabilities of UK£81m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Huntsworth’s ROCE
This is good to see, and with a sound ROCE, Huntsworth could be worth a closer look. Of course you might be able to find a better stock than Huntsworth. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Huntsworth better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
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.