Today we’ll evaluate Ariadne Australia Limited (ASX:ARA) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Ariadne Australia:
0.11 = AU$21m ÷ (AU$191m – AU$8.6m) (Based on the trailing twelve months to June 2018.)
So, Ariadne Australia has an ROCE of 11%.
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Does Ariadne Australia Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Ariadne Australia’s ROCE is fairly close to the Commercial Services industry average of 13%. Separate from Ariadne Australia’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Ariadne Australia delivered an ROCE of 11%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. How cyclical is Ariadne Australia? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Ariadne Australia’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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ariadne Australia has total assets of AU$191m and current liabilities of AU$8.6m. As a result, its current liabilities are equal to approximately 4.5% of its total assets. Low current liabilities have only a minimal impact on Ariadne Australia’s ROCE, making its decent returns more credible.
What We Can Learn From Ariadne Australia’s ROCE
This is good to see, and while better prospects may exist, Ariadne Australia seems worth researching further. Of course you might be able to find a better stock than Ariadne Australia. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Ariadne Australia 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 email@example.com.