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Today we'll look at Total Telcom Inc. (CVE:TTZ) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Total Telcom:
0.12 = CA$348k ÷ (CA$3.2m - CA$225k) (Based on the trailing twelve months to March 2020.)
So, Total Telcom has an ROCE of 12%.
Does Total Telcom Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Total Telcom's ROCE is meaningfully higher than the 9.9% average in the Communications industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Total Telcom sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Total Telcom currently has an ROCE of 12%, less than the 20% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Total Telcom's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. You can check if Total Telcom has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Total Telcom's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Total Telcom has current liabilities of CA$225k and total assets of CA$3.2m. Therefore its current liabilities are equivalent to approximately 7.1% of its total assets. With low current liabilities, Total Telcom's decent ROCE looks that much more respectable.
Our Take On Total Telcom's ROCE
If it is able to keep this up, Total Telcom could be attractive. There might be better investments than Total Telcom out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.