Is Porvair plc’s (LON:PRV) 13% Return On Capital Employed Good News?
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Today we'll evaluate Porvair plc (LON:PRV) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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'.
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 Porvair:
0.13 = UK£15m ÷ (UK£150m - UK£36m) (Based on the trailing twelve months to May 2019.)
Therefore, Porvair has an ROCE of 13%.
View our latest analysis for Porvair
Is Porvair's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Porvair's ROCE is around the 13% average reported by the Machinery industry. Independently of how Porvair compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Porvair's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Porvair.
Do Porvair'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Porvair has total assets of UK£150m and current liabilities of UK£36m. As a result, its current liabilities are equal to approximately 24% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Porvair's ROCE
This is good to see, and with a sound ROCE, Porvair could be worth a closer look. There might be better investments than Porvair 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 Porvair 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 editorial-team@simplywallst.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.
