Today we'll look at Eckoh plc (LON:ECK) 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. 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Eckoh:
0.061 = UK£1.2m ÷ (UK£41m - UK£21m) (Based on the trailing twelve months to March 2019.)
So, Eckoh has an ROCE of 6.1%.
Does Eckoh Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Eckoh's ROCE appears meaningfully below the 12% average reported by the IT industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Eckoh'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.
Eckoh's current ROCE of 6.1% is lower than 3 years ago, when the company reported a 8.1% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Eckoh'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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Eckoh's 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.
Eckoh has total assets of UK£41m and current liabilities of UK£21m. As a result, its current liabilities are equal to approximately 52% of its total assets. Eckoh's current liabilities are fairly high, making its ROCE look better than otherwise.
The Bottom Line On Eckoh's ROCE
Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might also be able to find a better stock than Eckoh. So you may wish to see this free collection of other companies that have grown earnings strongly.
Eckoh is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider 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.