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Today we'll evaluate Aeorema Communications plc (LON:AEO) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
How Do You Calculate Return On Capital Employed?
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 Aeorema Communications:
0.049 = UK£74k ÷ (UK£2.3m - UK£792k) (Based on the trailing twelve months to December 2018.)
Therefore, Aeorema Communications has an ROCE of 4.9%.
Does Aeorema Communications Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Aeorema Communications's ROCE is meaningfully below the Entertainment industry average of 7.0%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Aeorema Communications'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.
As we can see, Aeorema Communications currently has an ROCE of 4.9%, less than the 22% it reported 3 years ago. So investors might consider if it has had issues recently.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Aeorema Communications.
How Aeorema Communications'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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Aeorema Communications has total liabilities of UK£792k and total assets of UK£2.3m. As a result, its current liabilities are equal to approximately 35% of its total assets. Aeorema Communications has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On Aeorema Communications's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better buy than Aeorema Communications. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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. Thank you for reading.