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Why We’re Not Keen On NCC Group plc’s (LON:NCC) 7.9% Return On Capital

Today we are going to look at NCC Group plc (LON:NCC) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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’.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)

Or for NCC Group:

0.079 = UK£21m ÷ (UK£350m – UK£72m) (Based on the trailing twelve months to November 2018.)

So, NCC Group has an ROCE of 7.9%.

Check out our latest analysis for NCC Group

Does NCC Group Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see NCC Group’s ROCE is meaningfully below the IT industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, NCC Group’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.

LSE:NCC Past Revenue and Net Income, March 6th 2019
LSE:NCC Past Revenue and Net Income, March 6th 2019

It is important to remember that ROCE shows past performance, and is 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 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 NCC Group.

What Are Current Liabilities, And How Do They Affect NCC Group’s 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

NCC Group has total assets of UK£350m and current liabilities of UK£72m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On NCC Group’s ROCE

That said, NCC Group’s ROCE is mediocre, there may be more attractive investments around. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like NCC Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.