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What Can We Make Of Lectra SA’s (EPA:LSS) High Return On Capital?

Today we'll look at Lectra SA (EPA:LSS) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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:

ANUNCIO

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Lectra:

0.18 = €38m ÷ (€351m - €136m) (Based on the trailing twelve months to March 2020.)

So, Lectra has an ROCE of 18%.

Check out our latest analysis for Lectra

Does Lectra Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Lectra's ROCE is meaningfully better than the 9.1% average in the Software industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Lectra compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Lectra's current ROCE of 18% is lower than its ROCE in the past, which was 26%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Lectra's ROCE compares to its industry, and you can click it to see more detail on its past growth.

ENXTPA:LSS Past Revenue and Net Income May 25th 2020
ENXTPA:LSS Past Revenue and Net Income May 25th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Lectra's Current Liabilities Skew Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Lectra has current liabilities of €136m and total assets of €351m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. With this level of current liabilities, Lectra's ROCE is boosted somewhat.

Our Take On Lectra's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Lectra 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. 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.