Today we'll look at Novisource N.V. (AMS:NOVI) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. 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.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Novisource:
0.13 = €645k ÷ (€8.1m - €3.1m) (Based on the trailing twelve months to June 2019.)
So, Novisource has an ROCE of 13%.
Does Novisource Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Novisource's ROCE is meaningfully better than the 9.1% average in the Commercial Services industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Novisource's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Novisource reported an ROCE of 13% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Novisource's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. How cyclical is Novisource? 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 Novisource'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 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.
Novisource has total assets of €8.1m and current liabilities of €3.1m. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Novisource has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Novisource's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Novisource 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.
I will like Novisource better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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