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Why You Should Care About Perma-Pipe International Holdings, Inc.’s (NASDAQ:PPIH) Low Return On Capital

Simply Wall St

Today we are going to look at Perma-Pipe International Holdings, Inc. (NASDAQ:PPIH) to see whether it might be an attractive investment prospect. 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.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

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. 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 Perma-Pipe International Holdings:

0.077 = US$6.1m ÷ (US$115m - US$36m) (Based on the trailing twelve months to July 2019.)

Therefore, Perma-Pipe International Holdings has an ROCE of 7.7%.

Check out our latest analysis for Perma-Pipe International Holdings

Does Perma-Pipe International Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Perma-Pipe International Holdings's ROCE is meaningfully below the Machinery industry average of 11%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Perma-Pipe International Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Our data shows that Perma-Pipe International Holdings currently has an ROCE of 7.7%, compared to its ROCE of 3.1% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Perma-Pipe International Holdings's past growth compares to other companies.

NasdaqGM:PPIH Past Revenue and Net Income, October 14th 2019

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. If Perma-Pipe International Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Perma-Pipe International Holdings'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Perma-Pipe International Holdings has total assets of US$115m and current liabilities of US$36m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Perma-Pipe International Holdings has a medium level of current liabilities, which would boost its ROCE somewhat.

The Bottom Line On Perma-Pipe International Holdings's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. 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.

I will like Perma-Pipe International Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.