Today we'll look at Triad Group plc (LON:TRD) 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 up, we'll look at what ROCE is and how we calculate it. 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 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. 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?
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 Triad Group:
0.17 = UK£1.0m ÷ (UK£8.3m - UK£2.5m) (Based on the trailing twelve months to March 2019.)
So, Triad Group has an ROCE of 17%.
Does Triad Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Triad Group's ROCE appears to be substantially greater than the 13% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Triad Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Triad Group's current ROCE of 17% is lower than 3 years ago, when the company reported a 44% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Triad Group'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 only a point-in-time measure. You can check if Triad Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Triad Group's Current Liabilities And Their Impact On 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 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.
Triad Group has total assets of UK£8.3m and current liabilities of UK£2.5m. As a result, its current liabilities are equal to approximately 30% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Triad Group's ROCE
Overall, Triad Group has a decent ROCE and could be worthy of further research. Triad Group 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.