Today we’ll look at Pental Limited (ASX:PTL) 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed 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?
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 Pental:
0.088 = AU$5.0m ÷ (AU$76m – AU$19m) (Based on the trailing twelve months to June 2019.)
So, Pental has an ROCE of 8.8%.
Is Pental’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Pental’s ROCE appears to be significantly below the 13% average in the Household Products industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Pental’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.
You can see in the image below how Pental’s ROCE compares to its industry. Click to see more on 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. ROCE is only a point-in-time measure. If Pental is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Pental’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.
Pental has total liabilities of AU$19m and total assets of AU$76m. As a result, its current liabilities are equal to approximately 25% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Pental’s ROCE
With that in mind, we’re not overly impressed with Pental’s ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Pental. So you may wish to see this free collection of other companies that have grown earnings strongly.
Pental is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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