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Today we’ll evaluate Arco Platform Limited (NASDAQ:ARCE) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. 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.’
So, How Do We Calculate ROCE?
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 Arco Platform:
0.031 = R$76m ÷ (R$1.3b – R$63m) (Based on the trailing twelve months to September 2018.)
So, Arco Platform has an ROCE of 3.1%.
Is Arco Platform’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Arco Platform’s ROCE appears to be significantly below the 11% average in the Consumer Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Arco Platform compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Arco Platform.
What Are Current Liabilities, And How Do They Affect Arco Platform’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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Arco Platform has total assets of R$1.3b and current liabilities of R$63m. As a result, its current liabilities are equal to approximately 4.9% of its total assets. Arco Platform has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From Arco Platform’s ROCE
Nonetheless, there may be better places to invest your capital. You might be able to find a better buy than Arco Platform. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 email@example.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.