Is Austin Engineering Limited's (ASX:ANG) Capital Allocation Ability Worth Your Time?

Today we'll evaluate Austin Engineering Limited (ASX:ANG) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.

What is 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. 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.

So, How Do We Calculate ROCE?

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 Austin Engineering:

0.11 = AU$12m ÷ (AU$177m - AU$70m) (Based on the trailing twelve months to June 2019.)

So, Austin Engineering has an ROCE of 11%.

Check out our latest analysis for Austin Engineering

Does Austin Engineering Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Austin Engineering's ROCE appears to be around the 9.3% average of the Machinery industry. Regardless of where Austin Engineering sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Austin Engineering reported an ROCE of 11% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how Austin Engineering's ROCE compares to its industry.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Austin Engineering's Current Liabilities Skew 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.

Austin Engineering has total liabilities of AU$70m and total assets of AU$177m. As a result, its current liabilities are equal to approximately 40% of its total assets. With this level of current liabilities, Austin Engineering's ROCE is boosted somewhat.

Our Take On Austin Engineering's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Austin Engineering 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.