Today we are going to look at FP Newspapers Inc. (CVE:FP) 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. 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 amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 FP Newspapers:
0.35 = CA$1.6m ÷ (CA$4.9m - CA$183k) (Based on the trailing twelve months to June 2019.)
Therefore, FP Newspapers has an ROCE of 35%.
Is FP Newspapers's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, FP Newspapers's ROCE is meaningfully higher than the 9.2% average in the Media industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, FP Newspapers's ROCE currently appears to be excellent.
Our data shows that FP Newspapers currently has an ROCE of 35%, compared to its ROCE of 26% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how FP Newspapers's ROCE compares to its industry. Click to see more on past growth.
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, after all, simply a snap shot of a single year. If FP Newspapers is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect FP Newspapers's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
FP Newspapers has total assets of CA$4.9m and current liabilities of CA$183k. Therefore its current liabilities are equivalent to approximately 3.8% of its total assets. FP Newspapers has low current liabilities, which have a negligible impact on its relatively good ROCE.
What We Can Learn From FP Newspapers's ROCE
This suggests the company would be worth researching in more depth. FP Newspapers looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.