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Today we'll evaluate 888 Holdings plc (LON:888) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 888 Holdings:
0.55 = US$89m ÷ (US$381m - US$220m) (Based on the trailing twelve months to December 2018.)
So, 888 Holdings has an ROCE of 55%.
Is 888 Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. 888 Holdings's ROCE appears to be substantially greater than the 8.3% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, 888 Holdings's ROCE in absolute terms currently looks quite high.
In our analysis, 888 Holdings's ROCE appears to be 55%, compared to 3 years ago, when its ROCE was 35%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how 888 Holdings's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for 888 Holdings.
How 888 Holdings's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
888 Holdings has total assets of US$381m and current liabilities of US$220m. As a result, its current liabilities are equal to approximately 58% of its total assets. While a high level of current liabilities boosts its ROCE, 888 Holdings's returns are still very good.
The Bottom Line On 888 Holdings's ROCE
So we would be interested in doing more research here -- there may be an opportunity! 888 Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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. Thank you for reading.