Here’s why Radpol S.A.’s (WSE:RDL) Returns On Capital Matters So Much

By
Simply Wall St
Published
March 11, 2020
WSE:RDL

Today we are going to look at Radpol S.A. (WSE:RDL) 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.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 Radpol:

0.057 = zł7.5m ÷ (zł184m - zł53m) (Based on the trailing twelve months to September 2019.)

So, Radpol has an ROCE of 5.7%.

See our latest analysis for Radpol

Is Radpol's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Radpol's ROCE is meaningfully below the Electrical industry average of 20%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Radpol stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Radpol delivered an ROCE of 5.7%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how Radpol's ROCE compares to its industry, and you can click it to see more detail on its past growth.

WSE:RDL Past Revenue and Net Income, March 11th 2020
WSE:RDL Past Revenue and Net Income, March 11th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Radpol? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How Radpol's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Radpol has current liabilities of zł53m and total assets of zł184m. Therefore its current liabilities are equivalent to approximately 29% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

What We Can Learn From Radpol's ROCE

If Radpol continues to earn an uninspiring ROCE, there may be better places to invest. 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.

I will like Radpol better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.

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