Today we are going to look at Senetas Corporation Limited (ASX:SEN) to see whether it might be an attractive investment prospect. 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.
Firstly, we’ll go over how we calculate ROCE. 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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:
0.11 = AU$2.5m ÷ (AU$34m – AU$10m) (Based on the trailing twelve months to December 2019.)
Therefore, Senetas has an ROCE of 11%.
Does Senetas Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Senetas’s ROCE appears to be substantially greater than the 7.5% average in the Communications industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Senetas sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Senetas’s current ROCE of 11% is lower than 3 years ago, when the company reported a 19% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Senetas’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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can check if Senetas has cyclical profits by looking at 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. 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. As a result, its current liabilities are equal to approximately 30% of its total assets. Senetas has a medium level of current liabilities, which would boost the ROCE.
Our Take On Senetas’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Senetas 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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