Today we'll evaluate Newmark Security plc (LON:NWT) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. Overall, it is a valuable metric that has its flaws. 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 Newmark Security:
0.089 = UK£844k ÷ (UK£13m - UK£4.0m) (Based on the trailing twelve months to October 2019.)
So, Newmark Security has an ROCE of 8.9%.
Does Newmark Security Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Newmark Security's ROCE is around the 9.3% average reported by the Electronic industry. Separate from how Newmark Security stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
In our analysis, Newmark Security's ROCE appears to be 8.9%, compared to 3 years ago, when its ROCE was 0.5%. This makes us wonder if the company is improving. You can see in the image below how Newmark Security's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. If Newmark Security is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Newmark Security's Current Liabilities Impact 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Newmark Security has current liabilities of UK£4.0m and total assets of UK£13m. As a result, its current liabilities are equal to approximately 30% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On Newmark Security's ROCE
With that in mind, we're not overly impressed with Newmark Security's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Newmark Security. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.