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Should You Like Nine Entertainment Co. Holdings Limited’s (ASX:NEC) High Return On Capital Employed?

Simply Wall St

Today we'll look at Nine Entertainment Co. Holdings Limited (ASX:NEC) and reflect on its potential as an investment. 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.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?

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 Nine Entertainment Holdings:

0.11 = AU$381m ÷ (AU$4.4b - AU$865m) (Based on the trailing twelve months to June 2019.)

Therefore, Nine Entertainment Holdings has an ROCE of 11%.

View our latest analysis for Nine Entertainment Holdings

Is Nine Entertainment Holdings's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Nine Entertainment Holdings's ROCE appears to be substantially greater than the 8.3% average in the Media industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Nine Entertainment Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that, Nine Entertainment Holdings currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 6.8%. This makes us wonder if the company is improving. You can see in the image below how Nine Entertainment Holdings's ROCE compares to its industry. Click to see more on past growth.

ASX:NEC Past Revenue and Net Income, December 9th 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. 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 Nine Entertainment Holdings.

Do Nine Entertainment Holdings's Current Liabilities Skew 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Nine Entertainment Holdings has total assets of AU$4.4b and current liabilities of AU$865m. As a result, its current liabilities are equal to approximately 20% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

The Bottom Line On Nine Entertainment Holdings's ROCE

With that in mind, Nine Entertainment Holdings's ROCE appears pretty good. Nine Entertainment Holdings 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.

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.

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.