Today we are going to look at EuKedos S.p.A. (BIT:EUK) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. 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?
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 EuKedos:
0.017 = €2.3m ÷ (€153m – €21m) (Based on the trailing twelve months to June 2019.)
Therefore, EuKedos has an ROCE of 1.7%.
Is EuKedos’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see EuKedos’s ROCE is meaningfully below the Healthcare industry average of 4.8%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how EuKedos compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. It is likely that there are more attractive prospects out there.
EuKedos’s current ROCE of 1.7% is lower than its ROCE in the past, which was 4.0%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how EuKedos’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. 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 EuKedos.
Do EuKedos’s Current Liabilities Skew 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.
EuKedos has total assets of €153m and current liabilities of €21m. As a result, its current liabilities are equal to approximately 14% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From EuKedos’s ROCE
While that is good to see, EuKedos has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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