Today we are going to look at ALS Limited (ASX:ALQ) 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. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 ALS:
0.15 = AU$218m ÷ (AU$2.1b – AU$527m) (Based on the trailing twelve months to September 2018.)
So, ALS has an ROCE of 15%.
Is ALS’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, ALS’s ROCE appears to be around the 18% average of the Professional Services industry. Independently of how ALS compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, ALS currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 8.7%. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for ALS.
ALS’s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ALS has total liabilities of AU$527m and total assets of AU$2.1b. As a result, its current liabilities are equal to approximately 25% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On ALS’s ROCE
With that in mind, ALS’s ROCE appears pretty good. You might be able to find a better buy than ALS. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like ALS better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.