Today we'll look at We.Connect SA (EPA:ALWEC) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 We.Connect:
0.12 = €4.9m ÷ (€91m - €50m) (Based on the trailing twelve months to December 2018.)
So, We.Connect has an ROCE of 12%.
Is We.Connect's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that We.Connect's ROCE is fairly close to the Retail Distributors industry average of 14%. Regardless of where We.Connect sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We.Connect's current ROCE of 12% is lower than its ROCE in the past, which was 19%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how We.Connect's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is We.Connect? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How We.Connect's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
We.Connect has total liabilities of €50m and total assets of €91m. Therefore its current liabilities are equivalent to approximately 55% of its total assets. We.Connect has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On We.Connect's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. We.Connect 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.
I will like We.Connect better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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