Today we'll look at Playtech plc (LON:PTEC) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. 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 Playtech:
0.059 = €136m ÷ (€3.1b - €777m) (Based on the trailing twelve months to December 2019.)
So, Playtech has an ROCE of 5.9%.
Is Playtech's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Playtech's ROCE appears to be around the 7.2% average of the Hospitality industry. Aside from the industry comparison, Playtech's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that, Playtech currently has an ROCE of 5.9%, less than the 11% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Playtech's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Playtech's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Playtech has total assets of €3.1b and current liabilities of €777m. As a result, its current liabilities are equal to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On Playtech's ROCE
If Playtech continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Playtech. So you may wish to see this free collection of other companies that have grown earnings strongly.
There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.