Today we’ll evaluate Alpha Pro Tech, Ltd. (NYSEMKT:APT) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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?
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 Alpha Pro Tech:
0.084 = US$3.0m ÷ (US$38m – US$2.3m) (Based on the trailing twelve months to December 2019.)
Therefore, Alpha Pro Tech has an ROCE of 8.4%.
Does Alpha Pro Tech Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Alpha Pro Tech’s ROCE appears to be significantly below the 12% average in the Building industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Alpha Pro Tech’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
The image below shows how Alpha Pro Tech’s ROCE compares to its industry, and you can click it to see more detail on its 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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Alpha Pro Tech is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Alpha Pro Tech’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
Alpha Pro Tech has current liabilities of US$2.3m and total assets of US$38m. Therefore its current liabilities are equivalent to approximately 6.0% of its total assets. Alpha Pro Tech reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Alpha Pro Tech’s ROCE
If performance improves, then Alpha Pro Tech may be an OK investment, especially at the right valuation. Of course, you might also be able to find a better stock than Alpha Pro Tech. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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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