U.S. Markets closed

Why We’re Not Keen On Solarpack Corporacion Tecnologica, S.A.’s (BME:SPK) 1.6% Return On Capital

Simply Wall St

Today we'll look at Solarpack Corporacion Tecnologica, S.A. (BME:SPK) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First, 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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 Solarpack Corporacion Tecnologica:

0.016 = €8.9m ÷ (€690m - €140m) (Based on the trailing twelve months to September 2019.)

So, Solarpack Corporacion Tecnologica has an ROCE of 1.6%.

Check out our latest analysis for Solarpack Corporacion Tecnologica

Is Solarpack Corporacion Tecnologica's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Solarpack Corporacion Tecnologica's ROCE appears meaningfully below the 4.1% average reported by the Renewable Energy industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Solarpack Corporacion Tecnologica's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

Solarpack Corporacion Tecnologica's current ROCE of 1.6% is lower than 3 years ago, when the company reported a 31% ROCE. Therefore we wonder if the company is facing new headwinds. The image below shows how Solarpack Corporacion Tecnologica's ROCE compares to its industry, and you can click it to see more detail on its past growth.

BME:SPK Past Revenue and Net Income, February 9th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Solarpack Corporacion Tecnologica.

Do Solarpack Corporacion Tecnologica's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Solarpack Corporacion Tecnologica has total assets of €690m and current liabilities of €140m. As a result, its current liabilities are equal to approximately 20% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

Our Take On Solarpack Corporacion Tecnologica's ROCE

That's not a bad thing, however Solarpack Corporacion Tecnologica has a weak ROCE and may not be an attractive investment. 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 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.