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Today we’ll evaluate CWA S.A. (WSE:CWA) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 CWA:
0.021 = zł39k ÷ (zł3.2m – zł1.3m) (Based on the trailing twelve months to March 2019.)
So, CWA has an ROCE of 2.1%.
Is CWA’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, CWA’s ROCE appears to be significantly below the 3.8% average in the Professional Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how CWA stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If CWA is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How CWA’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 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.
CWA has total assets of zł3.2m and current liabilities of zł1.3m. Therefore its current liabilities are equivalent to approximately 42% of its total assets. With a medium level of current liabilities boosting the ROCE a little, CWA’s low ROCE is unappealing.
What We Can Learn From CWA’s ROCE
There are likely better investments out there. 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).
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 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.