Today we are going to look at Enevis Limited (ASX:ENE) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Enevis:
0.15 = AU$776k ÷ (AU$17m - AU$12m) (Based on the trailing twelve months to June 2019.)
So, Enevis has an ROCE of 15%.
Does Enevis Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Enevis's ROCE is around the 13% average reported by the Electrical industry. Regardless of where Enevis sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Enevis's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. How cyclical is Enevis? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Enevis's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Enevis has total assets of AU$17m and current liabilities of AU$12m. As a result, its current liabilities are equal to approximately 70% of its total assets. Enevis's current liabilities are fairly high, which increases its ROCE significantly.
Our Take On Enevis's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. There might be better investments than Enevis 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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