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What Can We Make Of Telecom Plus PLC’s (LON:TEP) High Return On Capital?

Simply Wall St

Today we are going to look at Telecom Plus PLC (LON:TEP) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we 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.

What is Return On Capital Employed (ROCE)?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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 Telecom Plus:

0.16 = UK£46m ÷ (UK£410m - UK£113m) (Based on the trailing twelve months to September 2019.)

So, Telecom Plus has an ROCE of 16%.

View our latest analysis for Telecom Plus

Is Telecom Plus's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Telecom Plus's ROCE appears to be substantially greater than the 5.2% average in the Integrated Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Telecom Plus compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

The image below shows how Telecom Plus's ROCE compares to its industry, and you can click it to see more detail on its past growth.

LSE:TEP Past Revenue and Net Income, January 15th 2020

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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Telecom Plus.

Do Telecom Plus's Current Liabilities Skew Its 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.

Telecom Plus has total liabilities of UK£113m and total assets of UK£410m. As a result, its current liabilities are equal to approximately 27% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From Telecom Plus's ROCE

This is good to see, and with a sound ROCE, Telecom Plus could be worth a closer look. Telecom Plus shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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 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.

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. Thank you for reading.