Today we'll evaluate P&F Industries, Inc. (NASDAQ:PFIN) to determine whether it could have potential as an investment idea. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. 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.'
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 P&F Industries:
0.018 = US$879k ÷ (US$58m - US$9.1m) (Based on the trailing twelve months to June 2019.)
So, P&F Industries has an ROCE of 1.8%.
Is P&F Industries's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, P&F Industries's ROCE appears meaningfully below the 12% average reported by the Consumer Durables industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how P&F Industries stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
P&F Industries's current ROCE of 1.8% is lower than 3 years ago, when the company reported a 3.3% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how P&F Industries'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, after all, simply a snap shot of a single year. How cyclical is P&F Industries? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How P&F Industries's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
P&F Industries has total assets of US$58m and current liabilities of US$9.1m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From P&F Industries's ROCE
That's not a bad thing, however P&F Industries has a weak ROCE and may not be an attractive investment. 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).
I will like P&F Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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.