Today we are going to look at Elementis plc (LON:ELM) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Elementis:
0.06 = US$104m ÷ (US$1.9b - US$176m) (Based on the trailing twelve months to December 2019.)
Therefore, Elementis has an ROCE of 6.0%.
Does Elementis Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Elementis's ROCE appears to be significantly below the 13% average in the Chemicals industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Elementis'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.
Elementis's current ROCE of 6.0% is lower than its ROCE in the past, which was 12%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Elementis's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Elementis.
Do Elementis's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Elementis has current liabilities of US$176m and total assets of US$1.9b. Therefore its current liabilities are equivalent to approximately 9.2% of its total assets. Elementis reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Elementis's ROCE
Elementis looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than Elementis. So you may wish to see this free collection of other companies that have grown earnings strongly.
Elementis 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 firstname.lastname@example.org. 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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