Today we'll look at Paperpack A.B.E.E. (ATH:PPAK) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 PaperpackE.E:
0.19 = €2.4m ÷ (€19m - €6.0m) (Based on the trailing twelve months to June 2019.)
Therefore, PaperpackE.E has an ROCE of 19%.
Does PaperpackE.E Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that PaperpackE.E's ROCE is meaningfully better than the 10% average in the Packaging 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 PaperpackE.E's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, PaperpackE.E currently has an ROCE of 19%, less than the 26% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how PaperpackE.E'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. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If PaperpackE.E is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do PaperpackE.E's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
PaperpackE.E has total assets of €19m and current liabilities of €6.0m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. PaperpackE.E has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On PaperpackE.E's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. PaperpackE.E shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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