Today we are going to look at Cerillion PLC (LON:CER) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. 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 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. In brief, it is a useful tool, but it is not without drawbacks. 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'.
So, How Do We Calculate ROCE?
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 Cerillion:
0.15 = UK£2.5m ÷ (UK£26m - UK£8.5m) (Based on the trailing twelve months to September 2019.)
So, Cerillion has an ROCE of 15%.
Does Cerillion Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Cerillion's ROCE is meaningfully higher than the 11% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Cerillion compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Cerillion's ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 6.6%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Cerillion's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Cerillion's 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.
Cerillion has total liabilities of UK£8.5m and total assets of UK£26m. Therefore its current liabilities are equivalent to approximately 33% of its total assets. Cerillion has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On Cerillion's ROCE
Cerillion's ROCE does look good, but the level of current liabilities also contribute to that. Cerillion 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 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.
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