Yahoo Finance Why We’re Not Keen On Stilo International plc’s (LON:STL) 3.5% Return On Capital
Today we are going to look at Stilo International plc (LON:STL) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. All else being equal, a better business will have a higher ROCE. 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'.
So, How Do We Calculate ROCE?
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 Stilo International:
0.035 = UK£129k ÷ (UK£4.2m - UK£436k) (Based on the trailing twelve months to December 2018.)
Therefore, Stilo International has an ROCE of 3.5%.
See our latest analysis for Stilo International
Is Stilo International's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Stilo International's ROCE appears to be significantly below the 10% average in the Software industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Stilo International compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. Readers may wish to look for more rewarding investments.
Stilo International's current ROCE of 3.5% is lower than 3 years ago, when the company reported a 8.4% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Stilo International'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. If Stilo International is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Stilo International's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Stilo International has total assets of UK£4.2m and current liabilities of UK£436k. Therefore its current liabilities are equivalent to approximately 10% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Stilo International's ROCE
While that is good to see, Stilo International has a low ROCE and does not look attractive in this analysis. 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
