Today we'll look at Park Lawn Corporation (TSE:PLC) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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.
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 Park Lawn:
0.023 = CA$30m ÷ (CA$1.3b - CA$33m) (Based on the trailing twelve months to September 2019.)
Therefore, Park Lawn has an ROCE of 2.3%.
Is Park Lawn's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Park Lawn's ROCE is meaningfully below the Consumer Services industry average of 7.4%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Park Lawn stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
You can see in the image below how Park Lawn's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Park Lawn'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Park Lawn has total liabilities of CA$33m and total assets of CA$1.3b. As a result, its current liabilities are equal to approximately 2.5% of its total assets. Park Lawn has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Park Lawn's ROCE
Still, investors could probably find more attractive prospects with better performance out there. You might be able to find a better investment than Park Lawn. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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