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Today we are going to look at Cleanaway Waste Management Limited (ASX:CWY) to see whether it might be an attractive investment prospect. 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. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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’.
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 Cleanaway Waste Management:
0.05 = AU$181m ÷ (AU$4.1b – AU$458m) (Based on the trailing twelve months to December 2018.)
Therefore, Cleanaway Waste Management has an ROCE of 5.0%.
Does Cleanaway Waste Management Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Cleanaway Waste Management’s ROCE is meaningfully below the Commercial Services industry average of 19%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Cleanaway Waste Management’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
In our analysis, Cleanaway Waste Management’s ROCE appears to be 5.0%, compared to 3 years ago, when its ROCE was 3.4%. 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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Cleanaway Waste Management’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cleanaway Waste Management has total assets of AU$4.1b and current liabilities of AU$458m. As a result, its current liabilities are equal to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Cleanaway Waste Management’s ROCE
Cleanaway Waste Management has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than Cleanaway Waste Management. 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).
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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 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.