Why You Should Care About PICO Holdings, Inc.’s (NASDAQ:PICO) Low Return On Capital

Today we’ll evaluate PICO Holdings, Inc. (NASDAQ:PICO) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding 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. Generally speaking a higher ROCE is better. 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 PICO Holdings:

0.049 = US$8.8m ÷ (US$183m – US$572k) (Based on the trailing twelve months to March 2019.)

So, PICO Holdings has an ROCE of 4.9%.

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Does PICO Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, PICO Holdings’s ROCE appears to be significantly below the 11% average in the Commercial Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how PICO Holdings compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.

PICO Holdings has an ROCE of 4.9%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving.

NasdaqGS:PICO Past Revenue and Net Income, May 27th 2019
NasdaqGS:PICO Past Revenue and Net Income, May 27th 2019

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. ROCE is only a point-in-time measure. If PICO Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do PICO Holdings’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

PICO Holdings has total assets of US$183m and current liabilities of US$572k. Therefore its current liabilities are equivalent to approximately 0.3% of its total assets. PICO Holdings has very few current liabilities, which have a minimal effect on its already low ROCE.

Our Take On PICO Holdings’s ROCE

Nonetheless, there may be better places to invest your capital. Of course, you might also be able to find a better stock than PICO Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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