Today we’ll look at Pharmanutra S.p.A. (BIT:PHN) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. 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. 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’.
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 Pharmanutra:
0.44 = €13m ÷ (€42m – €13m) (Based on the trailing twelve months to June 2019.)
So, Pharmanutra has an ROCE of 44%.
Does Pharmanutra Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Pharmanutra’s ROCE is meaningfully higher than the 12% average in the Personal Products industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Pharmanutra’s ROCE is currently very good.
Pharmanutra’s current ROCE of 44% is lower than 3 years ago, when the company reported a 60% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Pharmanutra’s ROCE compares to its industry.
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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Pharmanutra.
Do Pharmanutra’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 counter this, investors can check if a company has high current liabilities relative to total assets.
Pharmanutra has total liabilities of €13m and total assets of €42m. As a result, its current liabilities are equal to approximately 32% of its total assets. Pharmanutra has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From Pharmanutra’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. Pharmanutra 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.
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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. Thank you for reading.