Today we’ll look at Thermal Energy International Inc. (CVE:TMG) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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 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’.
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 Thermal Energy International:
0.085 = CA$489k ÷ (CA$13m – CA$6.0m) (Based on the trailing twelve months to August 2018.)
So, Thermal Energy International has an ROCE of 8.5%.
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Is Thermal Energy International’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Thermal Energy International’s ROCE appears to be around the 8.9% average of the Machinery industry. Setting aside the industry comparison for now, Thermal Energy International’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Thermal Energy International reported an ROCE of 8.5% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Thermal Energy International has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Thermal Energy International’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Thermal Energy International has total liabilities of CA$6.0m and total assets of CA$13m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Thermal Energy International’s middling level of current liabilities have the effect of boosting its ROCE a bit.
What We Can Learn From Thermal Energy International’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.