Today we'll look at Estoril Sol, SGPS, S.A. (ELI:ESON) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. 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.

Understanding 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. 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'.

So, How Do We Calculate ROCE?

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 Estoril Sol SGPS:

0.16 = €18m ÷ (€150m - €40m) (Based on the trailing twelve months to June 2019.)

So, Estoril Sol SGPS has an ROCE of 16%.

View our latest analysis for Estoril Sol SGPS

Is Estoril Sol SGPS's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Estoril Sol SGPS's ROCE is meaningfully higher than the 7.2% average in the Hospitality industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Estoril Sol SGPS compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that , Estoril Sol SGPS currently has an ROCE of 16% compared to its ROCE 3 years ago, which was 13%. This makes us wonder if the company is improving. The image below shows how Estoril Sol SGPS's ROCE compares to its industry, and you can click it to see more detail on its past growth.

When considering this metric, keep in mind that it is backwards looking, and 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Estoril Sol SGPS? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.