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Why We’re Not Keen On Capacent Holding AB (publ)’s (STO:CAPAC) 7.1% Return On Capital

Simply Wall St

Today we are going to look at Capacent Holding AB (publ) (STO:CAPAC) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. 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 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. 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?

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 Capacent Holding:

0.071 = kr9.5m ÷ (kr218m - kr85m) (Based on the trailing twelve months to September 2019.)

So, Capacent Holding has an ROCE of 7.1%.

See our latest analysis for Capacent Holding

Is Capacent Holding's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Capacent Holding's ROCE appears meaningfully below the 12% 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. Setting aside the industry comparison for now, Capacent Holding's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Capacent Holding's current ROCE of 7.1% is lower than 3 years ago, when the company reported a 14% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Capacent Holding's past growth compares to other companies.

OM:CAPAC Past Revenue and Net Income, December 25th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 Capacent Holding.

What Are Current Liabilities, And How Do They Affect Capacent Holding's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Capacent Holding has total assets of kr218m and current liabilities of kr85m. As a result, its current liabilities are equal to approximately 39% of its total assets. Capacent Holding's ROCE is improved somewhat by its moderate amount of current liabilities.

The Bottom Line On Capacent Holding's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than Capacent Holding. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.