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Why Eckoh plc’s (LON:ECK) Use Of Investor Capital Doesn’t Look Great

Lester Strauss

Today we are going to look at Eckoh plc (LON:ECK) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we’ll go over how we 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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 Eckoh:

0.10 = UK£2.1m ÷ (UK£38m – UK£18m) (Based on the trailing twelve months to September 2018.)

Therefore, Eckoh has an ROCE of 10%.

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Is Eckoh’s ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Eckoh’s ROCE is fairly close to the IT industry average of 11%. Regardless of where Eckoh sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that Eckoh currently has an ROCE of 10%, compared to its ROCE of 7.5% 3 years ago. This makes us wonder if the company is improving.

AIM:ECK Last Perf January 15th 19

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Eckoh.

What Are Current Liabilities, And How Do They Affect Eckoh’s ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Eckoh has total assets of UK£38m and current liabilities of UK£18m. As a result, its current liabilities are equal to approximately 47% of its total assets. Eckoh has a medium level of current liabilities, which would boost the ROCE.

Our Take On Eckoh’s ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Of course you might 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.

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.