Today we are going to look at ESI Energy Services Inc. (CNSX:OPI) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Overall, it is a valuable metric that has its flaws. 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 ESI Energy Services:
0.0045 = CA$207k ÷ (CA$48m - CA$2.6m) (Based on the trailing twelve months to September 2019.)
Therefore, ESI Energy Services has an ROCE of 0.5%.
Does ESI Energy Services Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see ESI Energy Services's ROCE is meaningfully below the Trade Distributors industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside ESI Energy Services's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
ESI Energy Services reported an ROCE of 0.5% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how ESI Energy Services'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 ESI Energy Services? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
ESI Energy Services'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.
ESI Energy Services has total liabilities of CA$2.6m and total assets of CA$48m. Therefore its current liabilities are equivalent to approximately 5.3% of its total assets. ESI Energy Services has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On ESI Energy Services's ROCE
Nevertheless, there are potentially more attractive companies to invest in. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 firstname.lastname@example.org. 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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