Today we are going to look at Culti Milano S.p.A. (BIT:CULT) to see whether it might be an attractive investment prospect. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Culti Milano:
0.058 = €582k ÷ (€13m - €2.9m) (Based on the trailing twelve months to December 2019.)
So, Culti Milano has an ROCE of 5.8%.
Is Culti Milano's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Culti Milano's ROCE is meaningfully below the Chemicals industry average of 9.3%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Culti Milano's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Culti Milano reported an ROCE of 5.8% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Culti Milano's past growth compares to other companies.
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, 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 Culti Milano.
What Are Current Liabilities, And How Do They Affect Culti Milano's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Culti Milano has current liabilities of €2.9m and total assets of €13m. As a result, its current liabilities are equal to approximately 23% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Culti Milano's ROCE
With that in mind, we're not overly impressed with Culti Milano's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Culti Milano. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
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