Are Zotefoams plc’s Returns On Capital Worth Investigating?

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

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. Overall, it is a valuable metric that has its flaws. 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?

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 Zotefoams:

0.12 = UK£11m ÷ (UK£127m - UK£28m) (Based on the trailing twelve months to December 2018.)

So, Zotefoams has an ROCE of 12%.

View our latest analysis for Zotefoams

Is Zotefoams's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Zotefoams's ROCE is around the 13% average reported by the Chemicals industry. Separate from Zotefoams's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

LSE:ZTF Past Revenue and Net Income, April 15th 2019
LSE:ZTF Past Revenue and Net Income, April 15th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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.

How Zotefoams'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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Zotefoams has total liabilities of UK£28m and total assets of UK£127m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From Zotefoams's ROCE

Overall, Zotefoams has a decent ROCE and could be worthy of further research. Zotefoams shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like Zotefoams better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, 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.