Today we'll evaluate M.T.I Wireless Edge Ltd. (LON:MWE) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 M.T.I Wireless Edge:
0.15 = US$3.3m ÷ (US$31m - US$8.4m) (Based on the trailing twelve months to June 2019.)
Therefore, M.T.I Wireless Edge has an ROCE of 15%.
Does M.T.I Wireless Edge Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that M.T.I Wireless Edge's ROCE is fairly close to the Communications industry average of 12%. Regardless of where M.T.I Wireless Edge sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, M.T.I Wireless Edge currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 8.3%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how M.T.I Wireless Edge's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
M.T.I Wireless Edge's Current Liabilities And Their Impact On Its 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 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.
M.T.I Wireless Edge has total liabilities of US$8.4m and total assets of US$31m. Therefore its current liabilities are equivalent to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On M.T.I Wireless Edge's ROCE
Overall, M.T.I Wireless Edge has a decent ROCE and could be worthy of further research. M.T.I Wireless Edge looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.