Today we are going to look at Technical Publications Service S.p.A. (BIT:TPS) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Technical Publications Service:
0.046 = €1.3m ÷ (€36m - €7.8m) (Based on the trailing twelve months to December 2019.)
Therefore, Technical Publications Service has an ROCE of 4.6%.
Does Technical Publications Service Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Technical Publications Service's ROCE is meaningfully below the Aerospace & Defense industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Technical Publications Service's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
We can see that, Technical Publications Service currently has an ROCE of 4.6%, less than the 60% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Technical Publications Service's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. How cyclical is Technical Publications Service? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Technical Publications Service'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.
Technical Publications Service has current liabilities of €7.8m and total assets of €36m. As a result, its current liabilities are equal to approximately 22% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Technical Publications Service's ROCE
With that in mind, we're not overly impressed with Technical Publications Service's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Technical Publications Service. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 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.
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