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Today we’ll look at P.A.M. Transportation Services, Inc. (NASDAQ:PTSI) and reflect on its potential as an investment. 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. 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 measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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’.
How Do You Calculate Return On Capital Employed?
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 P.A.M. Transportation Services:
0.12 = US$40m ÷ (US$466m – US$126m) (Based on the trailing twelve months to December 2018.)
Therefore, P.A.M. Transportation Services has an ROCE of 12%.
Is P.A.M. Transportation Services’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that P.A.M. Transportation Services’s ROCE is fairly close to the Transportation industry average of 12%. Independently of how P.A.M. Transportation Services compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If P.A.M. Transportation Services is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect P.A.M. Transportation Services’s 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 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.
P.A.M. Transportation Services has total liabilities of US$126m and total assets of US$466m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On P.A.M. Transportation Services’s ROCE
Overall, P.A.M. Transportation Services has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than P.A.M. Transportation Services. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.