Australia markets open in 8 hours 39 minutes

Why RPMGlobal Holdings Limited’s (ASX:RUL) Return On Capital Employed Might Be A Concern

Simply Wall St

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we are going to look at RPMGlobal Holdings Limited (ASX:RUL) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Generally speaking a higher ROCE is better. 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.'

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 RPMGlobal Holdings:

0.018 = AU$1.2m ÷ (AU$88m - AU$22m) (Based on the trailing twelve months to December 2018.)

So, RPMGlobal Holdings has an ROCE of 1.8%.

View our latest analysis for RPMGlobal Holdings

Does RPMGlobal Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see RPMGlobal Holdings's ROCE is meaningfully below the Software industry average of 19%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Putting aside RPMGlobal Holdings's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

RPMGlobal Holdings delivered an ROCE of 1.8%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how RPMGlobal Holdings's ROCE compares to its industry. Click to see more on past growth.

ASX:RUL Past Revenue and Net Income, July 8th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. How cyclical is RPMGlobal Holdings? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

RPMGlobal Holdings's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

RPMGlobal Holdings has total assets of AU$88m and current liabilities of AU$22m. As a result, its current liabilities are equal to approximately 25% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On RPMGlobal Holdings's ROCE

RPMGlobal Holdings has a poor ROCE, and there may be better investment prospects out there. Of course, you might also be able to find a better stock than RPMGlobal Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.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.