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Today we'll evaluate Kape Technologies plc (LON:KAPE) to determine whether it could have potential as an investment idea. 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 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.'
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 Kape Technologies:
0.063 = US$5.1m ÷ (US$100m - US$20m) (Based on the trailing twelve months to December 2018.)
Therefore, Kape Technologies has an ROCE of 6.3%.
Is Kape Technologies's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Kape Technologies's ROCE is meaningfully below the Software industry average of 8.8%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Kape Technologies's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Kape Technologies reported an ROCE of 6.3% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how Kape Technologies's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Kape Technologies.
What Are Current Liabilities, And How Do They Affect Kape Technologies's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Kape Technologies has total assets of US$100m and current liabilities of US$20m. As a result, its current liabilities are equal to approximately 20% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Kape Technologies's ROCE
If Kape Technologies continues to earn an uninspiring ROCE, there may be better places to invest. 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.
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.
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.