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Today we are going to look at Petards Group plc (LON:PEG) 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.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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'.
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 Petards Group:
0.14 = UK£1.2m ÷ (UK£15m - UK£5.7m) (Based on the trailing twelve months to December 2018.)
Therefore, Petards Group has an ROCE of 14%.
Check out our latest analysis for Petards Group
Is Petards Group's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Petards Group's ROCE is meaningfully better than the 9.6% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Petards Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Petards Group's current ROCE of 14% is lower than 3 years ago, when the company reported a 20% ROCE. This makes us wonder if the business is facing new challenges.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Petards Group's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.