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Today we'll look at Performance Technologies S.A. (ATH:PERF) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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'.
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 Performance Technologies:
0.49 = €2.1m ÷ (€14m - €9.3m) (Based on the trailing twelve months to December 2018.)
So, Performance Technologies has an ROCE of 49%.
Is Performance Technologies's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Performance Technologies's ROCE is meaningfully higher than the 14% average in the IT industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Performance Technologies's ROCE currently appears to be excellent.
We can see that , Performance Technologies currently has an ROCE of 49% compared to its ROCE 3 years ago, which was 8.1%. This makes us wonder if the company is improving. You can see in the image below how Performance Technologies's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. How cyclical is Performance Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Performance Technologies's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Performance Technologies has total liabilities of €9.3m and total assets of €14m. Therefore its current liabilities are equivalent to approximately 68% of its total assets. Performance Technologies's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
What We Can Learn From Performance Technologies's ROCE
So to us, the company is potentially worth investigating further. Performance Technologies 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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.