Today we are going to look at Zytronic plc (LON:ZYT) 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.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. Ultimately, it is a useful but imperfect metric. 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 Zytronic:
0.14 = UK£3.6m ÷ (UK£28m – UK£1.8m) (Based on the trailing twelve months to March 2019.)
Therefore, Zytronic has an ROCE of 14%.
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Is Zytronic’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Zytronic’s ROCE appears to be around the 14% average of the Electronic industry. Independently of how Zytronic compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, Zytronic currently has an ROCE of 14%, less than the 20% it reported 3 years ago. So investors might consider if it has had issues recently.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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.
Zytronic’s Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Zytronic has total assets of UK£28m and current liabilities of UK£1.8m. As a result, its current liabilities are equal to approximately 6.5% of its total assets. Low current liabilities have only a minimal impact on Zytronic’s ROCE, making its decent returns more credible.
Our Take On Zytronic’s ROCE
This is good to see, and while better prospects may exist, Zytronic seems worth researching further. Zytronic looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.