Today we'll look at Pentamaster International Limited (HKG:1665) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Pentamaster International:
0.31 = RM127m ÷ (RM564m - RM154m) (Based on the trailing twelve months to September 2019.)
Therefore, Pentamaster International has an ROCE of 31%.
Is Pentamaster International's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Pentamaster International's ROCE is meaningfully better than the 5.9% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Pentamaster International's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how Pentamaster International's past growth compares to other companies.
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. 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.
What Are Current Liabilities, And How Do They Affect Pentamaster International's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Pentamaster International has total liabilities of RM154m and total assets of RM564m. As a result, its current liabilities are equal to approximately 27% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Pentamaster International's ROCE
Low current liabilities and high ROCE is a good combination, making Pentamaster International look quite interesting. There might be better investments than Pentamaster International 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.
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