U.S. Markets closed

Is Ecology & Environment, Inc.’s (NASDAQ:EEI) 11% Return On Capital Employed Good News?

Today we’ll look at Ecology & Environment, Inc. (NASDAQ:EEI) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Ecology & Environment:

0.11 = US\$4.3m ÷ (US\$54m – US\$15m) (Based on the trailing twelve months to April 2018.)

So, Ecology & Environment has an ROCE of 11%.

Does Ecology & Environment Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Ecology & Environment’s ROCE is around the 11% average reported by the Commercial Services industry. Regardless of where Ecology & Environment sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. You can check if Ecology & Environment has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Ecology & Environment’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Ecology & Environment has total assets of US\$54m and current liabilities of US\$15m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On Ecology & Environment’s ROCE

With that in mind, Ecology & Environment’s ROCE appears pretty good. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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.