Today we'll evaluate Senetas Corporation Limited (ASX:SEN) to determine whether it could have potential as an investment idea. 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.
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. 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. Ultimately, it is a useful but imperfect metric. 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 Senetas:
0.10 = AU$2.4m ÷ (AU$34m - AU$10m) (Based on the trailing twelve months to December 2019.)
So, Senetas has an ROCE of 10%.
Does Senetas Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Senetas's ROCE appears to be substantially greater than the 7.5% average in the Communications industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Senetas compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Senetas's current ROCE of 10% is lower than its ROCE in the past, which was 19%, 3 years ago. So investors might consider if it has had issues recently. The image below shows how Senetas's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. If Senetas is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Senetas's Current Liabilities And Their Impact On 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 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.
Senetas has total assets of AU$34m and current liabilities of AU$10m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Senetas has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From Senetas's ROCE
Senetas's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than Senetas 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
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