Why You Should Care About Eckoh plc’s (LON:ECK) Low Return On Capital

Today we are going to look at Eckoh plc (LON:ECK) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, ROCE 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.'

So, How Do We Calculate ROCE?

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 Eckoh:

0.10 = UK£2.1m ÷ (UK£38m - UK£18m) (Based on the trailing twelve months to September 2018.)

Therefore, Eckoh has an ROCE of 10%.

View our latest analysis for Eckoh

Is Eckoh's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Eckoh's ROCE is around the 11% average reported by the IT industry. Separate from Eckoh's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

As we can see, Eckoh currently has an ROCE of 10% compared to its ROCE 3 years ago, which was 7.5%. This makes us think the business might be improving.

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. ROCE is only a point-in-time measure. You can see analyst predictions in our freereport on analyst forecasts for the company.

How Eckoh's Current Liabilities Impact 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) unfairly boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Eckoh has total assets of UK£38m and current liabilities of UK£18m. Therefore its current liabilities are equivalent to approximately 47% of its total assets. With this level of current liabilities, Eckoh's ROCE is boosted somewhat.

The Bottom Line On Eckoh's ROCE

Eckoh's ROCE does look good, but the level of current liabilities also contribute to that. The ROCE can give us an idea of the quality of a business, but we need to look deeper if we are considering a purchase. For example, I often check if insiders have been buying shares .

Of course Eckoh may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.