Yahoo Finance Are Legend Corporation Limited’s (ASX:LGD) High Returns Really That Great?
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Today we are going to look at Legend Corporation Limited (ASX:LGD) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 Legend:
0.12 = AU$10.0m ÷ (AU$134m – AU$33m) (Based on the trailing twelve months to December 2018.)
Therefore, Legend has an ROCE of 12%.
View our latest analysis for Legend
Does Legend Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Legend’s ROCE is meaningfully higher than the 9.5% average in the Trade Distributors 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 Legend compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is Legend? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Legend’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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Legend has total liabilities of AU$33m and total assets of AU$134m. As a result, its current liabilities are equal to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Legend’s ROCE
With that in mind, Legend’s ROCE appears pretty good. Of course you might be able to find a better stock than Legend. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Legend 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.
