Today we are going to look at Playtech plc (LON:PTEC) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
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. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Playtech:
0.058 = €140m ÷ (€3.4b - €931m) (Based on the trailing twelve months to June 2019.)
Therefore, Playtech has an ROCE of 5.8%.
Is Playtech's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Playtech's ROCE is meaningfully below the Hospitality industry average of 7.4%. This performance could be negative if sustained, as it suggests the business may underperform its 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.
Playtech's current ROCE of 5.8% is lower than 3 years ago, when the company reported a 9.8% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Playtech's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Playtech.
How Playtech's Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Playtech has total assets of €3.4b and current liabilities of €931m. As a result, its current liabilities are equal to approximately 28% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Playtech's ROCE
If Playtech continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Playtech. 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).
I will like Playtech better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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