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Today we are going to look at Civmec Limited (SGX:P9D) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Civmec:
0.11 = AU$29m ÷ (AU$474m – AU$176m) (Based on the trailing twelve months to December 2018.)
So, Civmec has an ROCE of 11%.
Is Civmec’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Civmec’s ROCE appears to be substantially greater than the 6.9% average in the Construction 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 Civmec compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Civmec’s current ROCE of 11% is lower than 3 years ago, when the company reported a 16% ROCE. So investors might consider if it has had issues recently.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. You can check if Civmec has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Civmec’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Civmec has total assets of AU$474m and current liabilities of AU$176m. Therefore its current liabilities are equivalent to approximately 37% of its total assets. Civmec has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From Civmec’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. But note: Civmec may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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. On rare occasion, data errors may occur. Thank you for reading.