Today we'll look at Elders Limited (ASX:ELD) 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. 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'.
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 Elders:
0.17 = AU$57m ÷ (AU$960m - AU$617m) (Based on the trailing twelve months to March 2019.)
Therefore, Elders has an ROCE of 17%.
Does Elders Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Elders's ROCE is meaningfully better than the 7.2% average in the Food 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. Regardless of where Elders sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Elders's current ROCE of 17% is lower than its ROCE in the past, which was 31%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Elders'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.
Elders's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Elders has total assets of AU$960m and current liabilities of AU$617m. Therefore its current liabilities are equivalent to approximately 64% of its total assets. Elders has a relatively high level of current liabilities, boosting its ROCE meaningfully.
Our Take On Elders's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. Elders 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.
Elders 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 email@example.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.