Today we are going to look at Vital Limited (NZSE:VTL) 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. Ultimately, it is a useful but imperfect metric. 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 Vital:
0.12 = NZ$6.7m ÷ (NZ$67m - NZ$10m) (Based on the trailing twelve months to June 2019.)
So, Vital has an ROCE of 12%.
Does Vital Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Vital's ROCE is around the 11% average reported by the Wireless Telecom industry. Regardless of where Vital sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how Vital's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Vital has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Vital's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Vital has total assets of NZ$67m and current liabilities of NZ$10m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From Vital's ROCE
This is good to see, and with a sound ROCE, Vital could be worth a closer look. Vital looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Vital better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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