Today we'll look at RCM Technologies, Inc. (NASDAQ:RCMT) 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.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is 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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 RCM Technologies:
0.09 = US$6.4m ÷ (US$92m - US$21m) (Based on the trailing twelve months to September 2019.)
So, RCM Technologies has an ROCE of 9.0%.
Is RCM Technologies's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, RCM Technologies's ROCE appears to be around the 11% average of the Professional Services industry. Aside from the industry comparison, RCM Technologies'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.
RCM Technologies's current ROCE of 9.0% is lower than its ROCE in the past, which was 13%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how RCM Technologies's ROCE compares to its industry, and you can click it to see more detail on its 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.
RCM Technologies's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
RCM Technologies has total liabilities of US$21m and total assets of US$92m. As a result, its current liabilities are equal to approximately 23% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From RCM Technologies's ROCE
With that in mind, we're not overly impressed with RCM Technologies's ROCE, so it may not be the most appealing prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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