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Don’t Buy Tekmar Group plc (LON:TGP) Until You Understand Its ROCE

Simply Wall St

Today we are going to look at Tekmar Group plc (LON:TGP) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. 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'.

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 Tekmar Group:

0.071 = UK£3.1m ÷ (UK£53m - UK£9.8m) (Based on the trailing twelve months to March 2019.)

So, Tekmar Group has an ROCE of 7.1%.

Check out our latest analysis for Tekmar Group

Does Tekmar Group Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Tekmar Group's ROCE appears to be around the 7.5% average of the Energy Services industry. Setting aside the industry comparison for now, Tekmar Group'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.

Our data shows that Tekmar Group currently has an ROCE of 7.1%, compared to its ROCE of 3.4% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Tekmar Group's past growth compares to other companies.

AIM:TGP Past Revenue and Net Income, July 27th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Remember that most companies like Tekmar Group are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tekmar Group.

Do Tekmar Group's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Tekmar Group has total liabilities of UK£9.8m and total assets of UK£53m. As a result, its current liabilities are equal to approximately 18% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From Tekmar Group's ROCE

If Tekmar Group continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Tekmar Group. 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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 editorial-team@simplywallst.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.