Today we are going to look at Smart Metering Systems plc (LON:SMS) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Smart Metering Systems:
0.12 = UK£29m ÷ (UK£450m - UK£211m) (Based on the trailing twelve months to December 2018.)
So, Smart Metering Systems has an ROCE of 12%.
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Is Smart Metering Systems's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Smart Metering Systems's ROCE is around the 14% average reported by the Electronic industry. Independently of how Smart Metering Systems compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Smart Metering Systems.
Smart Metering Systems's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
Smart Metering Systems has total assets of UK£450m and current liabilities of UK£211m. As a result, its current liabilities are equal to approximately 47% of its total assets. With this level of current liabilities, Smart Metering Systems's ROCE is boosted somewhat.
The Bottom Line On Smart Metering Systems's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Smart Metering Systems out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Smart Metering Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.