Today we'll evaluate CPT Global Limited (ASX:CGO) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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'.
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 CPT Global:
0.29 = AU$1.9m ÷ (AU$13m - AU$6.3m) (Based on the trailing twelve months to June 2019.)
So, CPT Global has an ROCE of 29%.
Does CPT Global Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, CPT Global's ROCE is meaningfully higher than the 15% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, CPT Global's ROCE currently appears to be excellent.
CPT Global has an ROCE of 29%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how CPT Global'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. You can check if CPT Global has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How CPT Global's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
CPT Global has total liabilities of AU$6.3m and total assets of AU$13m. As a result, its current liabilities are equal to approximately 49% of its total assets. CPT Global has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From CPT Global's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. CPT Global shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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.