Today we'll look at Estoril Sol, SGPS, S.A. (ELI:ESON) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
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 Estoril Sol SGPS:
0.16 = €18m ÷ (€150m - €40m) (Based on the trailing twelve months to June 2019.)
So, Estoril Sol SGPS has an ROCE of 16%.
Is Estoril Sol SGPS's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Estoril Sol SGPS's ROCE is meaningfully higher than the 7.2% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Estoril Sol SGPS compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Estoril Sol SGPS currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 13%. This makes us wonder if the company is improving. The image below shows how Estoril Sol SGPS's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 Estoril Sol SGPS? 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 Estoril Sol SGPS'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Estoril Sol SGPS has total liabilities of €40m and total assets of €150m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Estoril Sol SGPS's ROCE
This is good to see, and with a sound ROCE, Estoril Sol SGPS could be worth a closer look. Estoril Sol SGPS looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.