Here’s What Cerillion PLC’s (LON:CER) Return On Capital Can Tell Us

Today we’ll evaluate Cerillion PLC (LON:CER) to determine whether it could have potential as an investment idea. 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.

First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Cerillion:

0.11 = UK£1.9m ÷ (UK£23m – UK£6.3m) (Based on the trailing twelve months to September 2018.)

Therefore, Cerillion has an ROCE of 11%.

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Does Cerillion Have A Good ROCE?

One way to assess ROCE is to compare similar companies. It appears that Cerillion’s ROCE is fairly close to the Software industry average of 11%. Independently of how Cerillion compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Cerillion’s current ROCE of 11% is lower than 3 years ago, when the company reported a 19% ROCE. This makes us wonder if the business is facing new challenges.

AIM:CER Past Revenue and Net Income, May 21st 2019
AIM:CER Past Revenue and Net Income, May 21st 2019

Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Cerillion’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) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Cerillion has total assets of UK£23m and current liabilities of UK£6.3m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Cerillion’s ROCE

This is good to see, and with a sound ROCE, Cerillion could be worth a closer look. There might be better investments than Cerillion 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.

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.