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Examining Netcall plc’s (LON:NET) Weak Return On Capital Employed

Simply Wall St

Today we'll evaluate Netcall plc (LON:NET) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Netcall:

0.062 = UK£1.8m ÷ (UK£45m - UK£16m) (Based on the trailing twelve months to June 2019.)

Therefore, Netcall has an ROCE of 6.2%.

View our latest analysis for Netcall

Is Netcall's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Netcall's ROCE appears meaningfully below the 11% average reported by the Software industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Netcall's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

The image below shows how Netcall's ROCE compares to its industry, and you can click it to see more detail on its past growth.

AIM:NET Past Revenue and Net Income, December 4th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Netcall.

Netcall'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. 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.

Netcall has total assets of UK£45m and current liabilities of UK£16m. Therefore its current liabilities are equivalent to approximately 35% of its total assets. Netcall's middling level of current liabilities have the effect of boosting its ROCE a bit.

The Bottom Line On Netcall's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might also be able to find a better stock than Netcall. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.