Today we'll look at LleidaNetworks Serveis Telemàtics, S.A. (BME:LLN) 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. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. 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.'
So, How Do We Calculate ROCE?
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 LleidaNetworks Serveis Telemàtics:
0.12 = €529k ÷ (€8.9m - €4.4m) (Based on the trailing twelve months to December 2018.)
So, LleidaNetworks Serveis Telemàtics has an ROCE of 12%.
Does LleidaNetworks Serveis Telemàtics Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that LleidaNetworks Serveis Telemàtics's ROCE is meaningfully better than the 7.7% average in the Telecom industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from LleidaNetworks Serveis Telemàtics's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
LleidaNetworks Serveis Telemàtics delivered an ROCE of 12%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can see in the image below how LleidaNetworks Serveis Telemàtics's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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 LleidaNetworks Serveis Telemàtics? 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 LleidaNetworks Serveis Telemàtics's 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 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.
LleidaNetworks Serveis Telemàtics has total liabilities of €4.4m and total assets of €8.9m. Therefore its current liabilities are equivalent to approximately 50% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From LleidaNetworks Serveis Telemàtics's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. There might be better investments than LleidaNetworks Serveis Telemàtics out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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.