Today we are going to look at EL.En. S.p.A. (BIT:ELN) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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 EL.En:
0.12 = €28m ÷ (€360m - €118m) (Based on the trailing twelve months to March 2019.)
So, EL.En has an ROCE of 12%.
Is EL.En's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that EL.En's ROCE is fairly close to the Medical Equipment industry average of 12%. Separate from EL.En's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how EL.En's ROCE compares to its industry, and you can click it to see more detail on its 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for EL.En.
What Are Current Liabilities, And How Do They Affect EL.En's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
EL.En has total assets of €360m and current liabilities of €118m. As a result, its current liabilities are equal to approximately 33% of its total assets. EL.En has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On EL.En's ROCE
EL.En's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than EL.En out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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If you spot an error that warrants correction, please contact the editor at email@example.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.