U.S. Markets closed

Why EKF Diagnostics Holdings plc’s (LON:EKF) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll look at EKF Diagnostics Holdings plc (LON:EKF) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 EKF Diagnostics Holdings:

0.085 = UK£5.7m ÷ (UK£81m - UK£14m) (Based on the trailing twelve months to December 2018.)

So, EKF Diagnostics Holdings has an ROCE of 8.5%.

Check out our latest analysis for EKF Diagnostics Holdings

Is EKF Diagnostics Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, EKF Diagnostics Holdings's ROCE appears meaningfully below the 11% average reported by the Medical Equipment industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, EKF Diagnostics Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

EKF Diagnostics Holdings has an ROCE of 8.5%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how EKF Diagnostics Holdings's past growth compares to other companies.

AIM:EKF Past Revenue and Net Income, September 7th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for EKF Diagnostics Holdings.

How EKF Diagnostics Holdings's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

EKF Diagnostics Holdings has total liabilities of UK£14m and total assets of UK£81m. As a result, its current liabilities are equal to approximately 17% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

What We Can Learn From EKF Diagnostics Holdings's ROCE

That said, EKF Diagnostics Holdings's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than EKF Diagnostics Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like EKF Diagnostics 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.