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Why We’re Not Impressed By Distil plc’s (LON:DIS) 9.0% ROCE

Simply Wall St

Today we’ll evaluate Distil plc (LON:DIS) to determine whether it could have potential as an investment idea. 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.

First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Distil:

0.09 = UK£157k ÷ (UK£3.4m – UK£263k) (Based on the trailing twelve months to September 2018.)

Therefore, Distil has an ROCE of 9.0%.

View our latest analysis for Distil

Is Distil’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Distil’s ROCE appears meaningfully below the 15% average reported by the Beverage industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Distil stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Distil has an ROCE of 9.0%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.

AIM:DIS Past Revenue and Net Income, February 26th 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Distil.

What Are Current Liabilities, And How Do They Affect Distil’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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Distil has total liabilities of UK£263k and total assets of UK£3.4m. Therefore its current liabilities are equivalent to approximately 7.8% of its total assets. Distil has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

Our Take On Distil’s ROCE

If performance improves, then Distil may be an OK investment, especially at the right valuation. Of course you might be able to find a better stock than Distil. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Distil 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.