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Today we'll look at PL Group S.A. (WSE:PLG) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for PL Group:
0.099 = zł1.5m ÷ (zł16m - zł1.3m) (Based on the trailing twelve months to December 2018.)
So, PL Group has an ROCE of 9.9%.
Does PL Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, PL Group's ROCE appears to be significantly below the 18% average in the Specialty Retail 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, PL Group'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.
PL Group delivered an ROCE of 9.9%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
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. ROCE is, after all, simply a snap shot of a single year. How cyclical is PL Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do PL Group'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
PL Group has total liabilities of zł1.3m and total assets of zł16m. As a result, its current liabilities are equal to approximately 7.7% of its total assets. PL Group has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
The Bottom Line On PL Group's ROCE
PL Group looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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. Thank you for reading.