Today we are going to look at Cellnet Group Limited (ASX:CLT) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the 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 Cellnet Group:
0.04 = AU$993k ÷ (AU$47m - AU$23m) (Based on the trailing twelve months to June 2019.)
Therefore, Cellnet Group has an ROCE of 4.0%.
Does Cellnet Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Cellnet Group's ROCE appears to be around the 4.0% average of the Electronic industry. Independently of how Cellnet Group compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.1% available in government bonds. It is likely that there are more attractive prospects out there.
We can see that, Cellnet Group currently has an ROCE of 4.0%, less than the 14% it reported 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 Cellnet Group's past growth compares to other companies.
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. ROCE is only a point-in-time measure. How cyclical is Cellnet Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Cellnet Group's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Cellnet Group has total assets of AU$47m and current liabilities of AU$23m. As a result, its current liabilities are equal to approximately 48% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Cellnet Group's ROCE is concerning.
Our Take On Cellnet Group's ROCE
This company may not be the most attractive investment prospect. 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).
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 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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