Today we are going to look at Componenta Corporation (HEL:CTH1V) 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Componenta:
0.022 = €800k ÷ (€51m - €15m) (Based on the trailing twelve months to June 2019.)
Therefore, Componenta has an ROCE of 2.2%.
Does Componenta Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Componenta's ROCE appears meaningfully below the 13% average reported by the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Componenta compares to its industry, its ROCE in absolute terms is low; especially compared to the ~0.5% available in government bonds. It is likely that there are more attractive prospects out there.
Componenta reported an ROCE of 2.2% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how Componenta'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, after all, simply a snap shot of a single year. You can check if Componenta has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Componenta's Current Liabilities Impact 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Componenta has total liabilities of €15m and total assets of €51m. As a result, its current liabilities are equal to approximately 29% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Componenta's ROCE
While that is good to see, Componenta has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Componenta. 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).
I will like Componenta 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 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.