Today we'll look at Entersoft A.E. (ATH:ENTER) 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 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
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 Entersoft A.E:
0.20 = €2.6m ÷ (€17m - €4.1m) (Based on the trailing twelve months to June 2019.)
So, Entersoft A.E has an ROCE of 20%.
Does Entersoft A.E Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Entersoft A.E's ROCE appears to be substantially greater than the 9.2% average in the Software 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. Putting aside its position relative to its industry for now, in absolute terms, Entersoft A.E's ROCE is currently very good.
The image below shows how Entersoft A.E'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. How cyclical is Entersoft A.E? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Entersoft A.E'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Entersoft A.E has total assets of €17m and current liabilities of €4.1m. As a result, its current liabilities are equal to approximately 25% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Entersoft A.E's ROCE
This is good to see, and with such a high ROCE, Entersoft A.E may be worth a closer look. Entersoft A.E shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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