Today we are going to look at Brook Crompton Holdings Ltd. (SGX:AWC) 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.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding 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.’
So, How Do We Calculate ROCE?
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 Brook Crompton Holdings:
0.14 = S$5.1m ÷ (S$50m – S$14m) (Based on the trailing twelve months to June 2019.)
Therefore, Brook Crompton Holdings has an ROCE of 14%.
Does Brook Crompton Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Brook Crompton Holdings’s ROCE is meaningfully higher than the 3.5% 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 Brook Crompton Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. If Brook Crompton Holdings is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Brook Crompton Holdings’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 counter this, investors can check if a company has high current liabilities relative to total assets.
Brook Crompton Holdings has total liabilities of S$14m and total assets of S$50m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Brook Crompton Holdings’s ROCE
With that in mind, Brook Crompton Holdings’s ROCE appears pretty good. Brook Crompton Holdings 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.