Don’t Buy Profile Systems & Software A.E. (ATH:PROF) Until You Understand Its ROCE

May 23, 2019

Today we'll look at Profile Systems & Software A.E. (ATH:PROF) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 Profile Systems & Software A.E:

0.082 = €2.0m ÷ (€36m - €12m) (Based on the trailing twelve months to December 2018.)

So, Profile Systems & Software A.E has an ROCE of 8.2%.

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Is Profile Systems & Software A.E's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Profile Systems & Software A.E's ROCE is fairly close to the Software industry average of 7.7%. Separate from how Profile Systems & Software A.E stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Our data shows that Profile Systems & Software A.E currently has an ROCE of 8.2%, compared to its ROCE of 5.1% 3 years ago. This makes us think the business might be improving.

ATSE:PROF Past Revenue and Net Income, May 24th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If Profile Systems & Software A.E is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Profile Systems & Software A.E's Current Liabilities Impact 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Profile Systems & Software A.E has total liabilities of €12m and total assets of €36m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. Profile Systems & Software A.E's middling level of current liabilities have the effect of boosting its ROCE a bit.

What We Can Learn From Profile Systems & Software A.E's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.