Today we'll look at Radici Pietro Industries & Brands S.p.A. (BIT:RAD) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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'.
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 Radici Pietro Industries & Brands:
0.05 = €2.2m ÷ (€96m - €52m) (Based on the trailing twelve months to June 2019.)
Therefore, Radici Pietro Industries & Brands has an ROCE of 5.0%.
Is Radici Pietro Industries & Brands's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Radici Pietro Industries & Brands's ROCE appears to be significantly below the 12% average in the Consumer Durables industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Radici Pietro Industries & Brands's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
The image below shows how Radici Pietro Industries & Brands's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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 Radici Pietro Industries & Brands.
What Are Current Liabilities, And How Do They Affect Radici Pietro Industries & Brands's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Radici Pietro Industries & Brands has total assets of €96m and current liabilities of €52m. Therefore its current liabilities are equivalent to approximately 54% of its total assets. Radici Pietro Industries & Brands has a fairly high level of current liabilities, meaningfully impacting its ROCE.
What We Can Learn From Radici Pietro Industries & Brands's ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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