Why You Should Care About Enalyzer A/S’s (CPH:ENALYZ) Low Return On Capital
Today we'll evaluate Enalyzer A/S (CPH:ENALYZ) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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 Enalyzer:
0.064 = ø819k ÷ (ø20m - ø7.4m) (Based on the trailing twelve months to December 2018.)
Therefore, Enalyzer has an ROCE of 6.4%.
View our latest analysis for Enalyzer
Is Enalyzer's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Enalyzer's ROCE appears meaningfully below the 11% average reported by the Software industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Enalyzer stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
Enalyzer's current ROCE of 6.4% is lower than its ROCE in the past, which was 16%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Enalyzer's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. How cyclical is Enalyzer? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Enalyzer's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Enalyzer has total assets of ø20m and current liabilities of ø7.4m. As a result, its current liabilities are equal to approximately 37% of its total assets. Enalyzer has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On Enalyzer's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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. Thank you for reading.
