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What Can We Make Of Arcontech Group plc’s (LON:ARC) High Return On Capital?

Simply Wall St

Today we'll evaluate Arcontech Group plc (LON:ARC) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Arcontech Group:

0.19 = UK£769k ÷ (UK£5.7m - UK£1.6m) (Based on the trailing twelve months to December 2018.)

So, Arcontech Group has an ROCE of 19%.

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Is Arcontech Group's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Arcontech Group's ROCE appears to be substantially greater than the 10% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Arcontech Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

AIM:ARC Past Revenue and Net Income, May 24th 2019

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Arcontech Group.

Do Arcontech Group's Current Liabilities Skew 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Arcontech Group has total assets of UK£5.7m and current liabilities of UK£1.6m. As a result, its current liabilities are equal to approximately 28% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Arcontech Group's ROCE

This is good to see, and with a sound ROCE, Arcontech Group could be worth a closer look. Arcontech Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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 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.