Today we'll look at Eckoh plc (LON:ECK) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. 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.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Eckoh:
0.17 = UK£3.6m ÷ (UK£44m - UK£22m) (Based on the trailing twelve months to September 2019.)
Therefore, Eckoh has an ROCE of 17%.
Is Eckoh's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Eckoh's ROCE is meaningfully higher than the 12% average in the IT industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Eckoh's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Eckoh currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 6.1%. This makes us wonder if the company is improving. You can see in the image below how Eckoh's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Eckoh'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Eckoh has total assets of UK£44m and current liabilities of UK£22m. Therefore its current liabilities are equivalent to approximately 51% of its total assets. Eckoh's current liabilities are fairly high, which increases its ROCE significantly.
The Bottom Line On Eckoh's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Eckoh 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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