Today we'll look at Proximus PLC (EBR:PROX) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. 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. 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'.
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 Proximus:
0.12 = €791m ÷ (€8.9b - €2.1b) (Based on the trailing twelve months to September 2019.)
So, Proximus has an ROCE of 12%.
Is Proximus's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Proximus's ROCE appears to be substantially greater than the 8.8% average in the Telecom industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Proximus compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Proximus's current ROCE of 12% is lower than its ROCE in the past, which was 16%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Proximus'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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Proximus's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Proximus has total assets of €8.9b and current liabilities of €2.1b. As a result, its current liabilities are equal to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Proximus's ROCE
This is good to see, and with a sound ROCE, Proximus could be worth a closer look. There might be better investments than Proximus 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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