Today we’ll look at Kelly Partners Group Holdings Limited (ASX:KPG) and reflect on its potential as an investment. 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. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding 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?
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 Kelly Partners Group Holdings:
0.25 = AU$9.9m ÷ (AU$50m – AU$11m) (Based on the trailing twelve months to June 2019.)
Therefore, Kelly Partners Group Holdings has an ROCE of 25%.
Is Kelly Partners Group Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Kelly Partners Group Holdings’s ROCE appears to be substantially greater than the 19% average in the Professional Services industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Kelly Partners Group Holdings’s ROCE currently appears to be excellent.
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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kelly Partners Group Holdings.
Do Kelly Partners Group Holdings’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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Kelly Partners Group Holdings has total liabilities of AU$11m and total assets of AU$50m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
The Bottom Line On Kelly Partners Group Holdings’s ROCE
Low current liabilities and high ROCE is a good combination, making Kelly Partners Group Holdings look quite interesting. There might be better investments than Kelly Partners Group Holdings 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.
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