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Should You Like Ecosuntek S.p.A.’s (BIT:ECK) High Return On Capital Employed?

Simply Wall St

Today we are going to look at Ecosuntek S.p.A. (BIT:ECK) 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.

First up, we'll look at what ROCE is and how we calculate it. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?

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 Ecosuntek:

0.086 = €2.3m ÷ (€57m - €31m) (Based on the trailing twelve months to June 2019.)

Therefore, Ecosuntek has an ROCE of 8.6%.

View our latest analysis for Ecosuntek

Is Ecosuntek's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Ecosuntek's ROCE appears to be substantially greater than the 5.3% average in the Renewable Energy 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. Setting aside the industry comparison for now, Ecosuntek's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Our data shows that Ecosuntek currently has an ROCE of 8.6%, compared to its ROCE of 2.4% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Ecosuntek's ROCE compares to its industry. Click to see more on past growth.

BIT:ECK Past Revenue and Net Income, January 20th 2020

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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Ecosuntek? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

Ecosuntek's Current Liabilities And Their Impact On Its 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 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.

Ecosuntek has total liabilities of €31m and total assets of €57m. Therefore its current liabilities are equivalent to approximately 53% of its total assets. Ecosuntek has a fairly high level of current liabilities, meaningfully impacting its ROCE.

Our Take On Ecosuntek's ROCE

Even so, the company reports a mediocre ROCE, and there may be better investments out there. 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.

I will like Ecosuntek better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.