Today we’ll evaluate Perma-Fix Environmental Services, Inc. (NASDAQ:PESI) to determine whether it could have potential as an investment idea. 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. Finally, we’ll look at how its current liabilities affect 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Perma-Fix Environmental Services:
0.0091 = -US$2.7m ÷ (US$59m – US$20m) (Based on the trailing twelve months to September 2018.)
So, Perma-Fix Environmental Services has an ROCE of 0.9%.
Is Perma-Fix Environmental Services’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Perma-Fix Environmental Services’s ROCE is meaningfully below the Commercial Services industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Perma-Fix Environmental Services compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. Readers may wish to look for more rewarding investments.
Perma-Fix Environmental Services’s current ROCE of 0.9% is lower than 3 years ago, when the company reported a 2.4% ROCE. Therefore we wonder if the company is facing new headwinds.
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. If Perma-Fix Environmental Services is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Perma-Fix Environmental Services’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Perma-Fix Environmental Services has total assets of US$59m and current liabilities of US$20m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. With a medium level of current liabilities boosting the ROCE a little, Perma-Fix Environmental Services’s low ROCE is unappealing.
Our Take On Perma-Fix Environmental Services’s ROCE
There are likely better investments out there. You might be able to find a better buy than Perma-Fix Environmental Services. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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.