Are Pharmanutra S.p.A.’s (BIT:PHN) High Returns Really That Great?

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Today we are going to look at Pharmanutra S.p.A. (BIT:PHN) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?

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 Pharmanutra:

0.42 = €12m ÷ (€41m – €13m) (Based on the trailing twelve months to December 2018.)

So, Pharmanutra has an ROCE of 42%.

See our latest analysis for Pharmanutra

Is Pharmanutra’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Pharmanutra’s ROCE is meaningfully better than the 14% average in the Personal Products industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Pharmanutra’s ROCE is currently very good.

BIT:PHN Past Revenue and Net Income, June 13th 2019
BIT:PHN Past Revenue and Net Income, June 13th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Pharmanutra’s Current Liabilities And Their Impact On Its 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 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) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Pharmanutra has total assets of €41m and current liabilities of €13m. As a result, its current liabilities are equal to approximately 31% of its total assets. Pharmanutra has a medium level of current liabilities, boosting its ROCE somewhat.

What We Can Learn From Pharmanutra’s ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. There might be better investments than Pharmanutra out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.