Today we'll look at Primeserv Group Limited (JSE:PMV) 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. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Primeserv Group:
0.17 = R26m ÷ (R213m - R59m) (Based on the trailing twelve months to September 2019.)
Therefore, Primeserv Group has an ROCE of 17%.
Check out our latest analysis for Primeserv Group
Is Primeserv Group's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Primeserv Group's ROCE is meaningfully better than the 13% average in the Professional Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Primeserv Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Primeserv Group's past growth compares to other companies.
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, after all, simply a snap shot of a single year. How cyclical is Primeserv Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Primeserv Group'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Primeserv Group has total liabilities of R59m and total assets of R213m. As a result, its current liabilities are equal to approximately 28% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Primeserv Group's ROCE
Overall, Primeserv Group has a decent ROCE and could be worthy of further research. Primeserv Group 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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