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Today we are going to look at Thorney Technologies Ltd (ASX:TEK) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. 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 Thorney Technologies:
0.084 = AU$5.4m ÷ (AU$65m – AU$1.2m) (Based on the trailing twelve months to June 2018.)
Therefore, Thorney Technologies has an ROCE of 8.4%.
Does Thorney Technologies Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Thorney Technologies’s ROCE is fairly close to the Oil and Gas industry average of 7.7%. Aside from the industry comparison, Thorney Technologies’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Thorney Technologies reported an ROCE of 8.4% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving.
It is important to remember that ROCE shows past performance, and is 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. Given the industry it operates in, Thorney Technologies could be considered cyclical. How cyclical is Thorney Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Thorney Technologies’s Current Liabilities And Their Impact On Its 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 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.
Thorney Technologies has total assets of AU$65m and current liabilities of AU$1.2m. As a result, its current liabilities are equal to approximately 1.9% of its total assets. With low levels of current liabilities, at least Thorney Technologies’s mediocre ROCE is not unduly boosted.
What We Can Learn From Thorney Technologies’s ROCE
Thorney Technologies looks like an ok business, but on this analysis it is not at the top of our buy list. But note: Thorney Technologies may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Thorney Technologies 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 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.