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Today we'll look at Sonel S.A. ( WSE:SON ) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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 '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?
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 Sonel:
0.11 = zł9.4m ÷ (zł95m - zł12m) (Based on the trailing twelve months to December 2018.)
Therefore, Sonel has an ROCE of 11%.
Is Sonel's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Sonel's ROCE is around the 13% average reported by the Electronic industry. Separate from Sonel's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Sonel's current ROCE of 11% is lower than its ROCE in the past, which was 18%, 3 years ago. This makes us wonder if the business is facing new challenges.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. You can check if Sonel has cyclical profits by looking at this free graph of past earnings, revenue and cash flow .
Do Sonel's Current Liabilities Skew 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sonel has total assets of zł95m and current liabilities of zł12m. As a result, its current liabilities are equal to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Sonel's ROCE
Overall, Sonel has a decent ROCE and could be worthy of further research. Sonel shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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.