Why PHSC plc’s (LON:PHSC) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll look at PHSC plc (LON:PHSC) 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.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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'.

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 PHSC:

0.047 = UK£244k ÷ (UK£5.9m - UK£730k) (Based on the trailing twelve months to March 2019.)

Therefore, PHSC has an ROCE of 4.7%.

See our latest analysis for PHSC

Does PHSC Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, PHSC's ROCE appears to be significantly below the 9.8% average in the Healthcare industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, PHSC's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

The image below shows how PHSC's ROCE compares to its industry, and you can click it to see more detail on its past growth.

AIM:PHSC Past Revenue and Net Income, October 10th 2019

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. How cyclical is PHSC? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

How PHSC's Current Liabilities Impact 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

PHSC has total liabilities of UK£730k and total assets of UK£5.9m. As a result, its current liabilities are equal to approximately 12% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From PHSC's ROCE

That said, PHSC's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than PHSC. So you may wish to see this free collection of other companies that have grown earnings strongly.

PHSC is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.

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.