Today we'll look at Hydrogen Group Plc (LON:HYDG) 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. Second, we'll look at its ROCE compared to similar companies. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Hydrogen Group:
0.12 = UK£3.2m ÷ (UK£44m - UK£17m) (Based on the trailing twelve months to June 2019.)
Therefore, Hydrogen Group has an ROCE of 12%.
Is Hydrogen Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Hydrogen Group's ROCE appears meaningfully below the 15% average reported by the Professional Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from Hydrogen Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Hydrogen Group currently has an ROCE of 12%, compared to its ROCE of 3.2% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how Hydrogen Group's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Hydrogen Group.
How Hydrogen Group's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Hydrogen Group has total liabilities of UK£17m and total assets of UK£44m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. Hydrogen Group has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Hydrogen Group's ROCE
Hydrogen Group's ROCE does look good, but the level of current liabilities also contribute to that. Hydrogen Group 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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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