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Today we'll evaluate PPHE Hotel Group Limited (LON:PPH) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
How Do You Calculate Return On Capital Employed?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for PPHE Hotel Group:
0.054 = UK£81m ÷ (UK£1.6b - UK£71m) (Based on the trailing twelve months to December 2019.)
Therefore, PPHE Hotel Group has an ROCE of 5.4%.
Is PPHE Hotel Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, PPHE Hotel Group's ROCE appears meaningfully below the 6.9% average reported by the Hospitality industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, PPHE Hotel Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
You can click on the image below to see (in greater detail) how PPHE Hotel Group's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for PPHE Hotel Group.
PPHE Hotel Group's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
PPHE Hotel Group has total assets of UK£1.6b and current liabilities of UK£71m. Therefore its current liabilities are equivalent to approximately 4.5% of its total assets. PPHE Hotel Group reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
Our Take On PPHE Hotel Group's ROCE
PPHE Hotel Group looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than PPHE Hotel Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.