Why Trackwise Designs Plc’s (LON:TWD) Return On Capital Employed Looks Uninspiring

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Today we are going to look at Trackwise Designs Plc (LON:TWD) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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’.

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 Trackwise Designs:

0.047 = UK£67k ÷ (UK£4.7m – UK£2.3m) (Based on the trailing twelve months to June 2018.)

So, Trackwise Designs has an ROCE of 4.7%.

See our latest analysis for Trackwise Designs

Is Trackwise Designs’s ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Trackwise Designs’s ROCE is meaningfully below the Electronic industry average of 14%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Trackwise Designs’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

AIM:TWD Last Perf February 6th 19
AIM:TWD Last Perf February 6th 19

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 Trackwise Designs.

What Are Current Liabilities, And How Do They Affect Trackwise Designs’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Trackwise Designs has total assets of UK£4.7m and current liabilities of UK£2.3m. Therefore its current liabilities are equivalent to approximately 50% of its total assets. Trackwise Designs has a medium level of current liabilities, which would boost its ROCE somewhat.

Our Take On Trackwise Designs’s ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course you might be able to find a better stock than Trackwise Designs. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 editorial-team@simplywallst.com.