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Here’s why ES-System Spólka Akcyjna’s (WSE:ESS) Returns On Capital Matters So Much

Simply Wall St

Today we'll look at ES-System Spólka Akcyjna (WSE:ESS) 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. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on 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. 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 ES-System Spólka Akcyjna:

0.031 = zł4.6m ÷ (zł179m - zł33m) (Based on the trailing twelve months to December 2018.)

So, ES-System Spólka Akcyjna has an ROCE of 3.1%.

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View our latest analysis for ES-System Spólka Akcyjna

Is ES-System Spólka Akcyjna's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see ES-System Spólka Akcyjna's ROCE is meaningfully below the Building industry average of 9.4%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how ES-System Spólka Akcyjna stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

ES-System Spólka Akcyjna's current ROCE of 3.1% is lower than 3 years ago, when the company reported a 6.1% ROCE. Therefore we wonder if the company is facing new headwinds.

WSE:ESS Past Revenue and Net Income, May 15th 2019

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. If ES-System Spólka Akcyjna is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How ES-System Spólka Akcyjna'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. 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.

ES-System Spólka Akcyjna has total assets of zł179m and current liabilities of zł33m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

The Bottom Line On ES-System Spólka Akcyjna's ROCE

ES-System Spólka Akcyjna has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.