Today we'll look at Farminveste - SGPS, S.A. (ELI:MLFMV) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, 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. In general, businesses with a higher ROCE are usually better quality. 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 Farminveste - SGPS:
0.037 = €13m ÷ (€532m - €194m) (Based on the trailing twelve months to December 2018.)
So, Farminveste - SGPS has an ROCE of 3.7%.
Does Farminveste - SGPS Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Farminveste - SGPS's ROCE appears meaningfully below the 7.5% average reported by the Healthcare industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Farminveste - SGPS stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
You can see in the image below how Farminveste - SGPS's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Farminveste - SGPS has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Farminveste - SGPS's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Farminveste - SGPS has total assets of €532m and current liabilities of €194m. Therefore its current liabilities are equivalent to approximately 37% of its total assets. Farminveste - SGPS's middling level of current liabilities have the effect of boosting its ROCE a bit.
What We Can Learn From Farminveste - SGPS'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 investment than Farminveste - SGPS. 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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