U.S. Markets close in 5 hrs 56 mins

Here’s why Poligrafica S. Faustino S.p.A.’s (BIT:PSF) Returns On Capital Matters So Much

Simply Wall St

Today we'll evaluate Poligrafica S. Faustino S.p.A. (BIT:PSF) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. 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'.

So, How Do We Calculate ROCE?

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 Poligrafica S. Faustino:

0.031 = €552k ÷ (€43m - €25m) (Based on the trailing twelve months to March 2019.)

So, Poligrafica S. Faustino has an ROCE of 3.1%.

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

View our latest analysis for Poligrafica S. Faustino

Is Poligrafica S. Faustino's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Poligrafica S. Faustino's ROCE is meaningfully below the Commercial Services industry average of 5.0%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Poligrafica S. Faustino stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

Poligrafica S. Faustino's current ROCE of 3.1% is lower than its ROCE in the past, which was 6.7%, 3 years ago. This makes us wonder if the business is facing new challenges.

BIT:PSF Past Revenue and Net Income, May 24th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. You can check if Poligrafica S. Faustino has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Poligrafica S. Faustino's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Poligrafica S. Faustino has total assets of €43m and current liabilities of €25m. Therefore its current liabilities are equivalent to approximately 58% of its total assets. Poligrafica S. Faustino has a fairly high level of current liabilities, boosting its ROCE.

Our Take On Poligrafica S. Faustino's ROCE

Poligrafica S. Faustino's ROCE is also pretty low (in absolute terms), making the stock look unattractive on this analysis. Of course, you might also be able to find a better stock than Poligrafica S. Faustino. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.