Today we’ll look at Aeeris Limited (ASX:AER) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 Aeeris:
0.045 = AU$38k ÷ (AU$1.2m – AU$397k) (Based on the trailing twelve months to June 2018.)
So, Aeeris has an ROCE of 4.5%.
Does Aeeris Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Aeeris’s ROCE is meaningfully below the Interactive Media and Services industry average of 30%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Aeeris’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Aeeris delivered an ROCE of 4.5%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if Aeeris has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Aeeris’s Current Liabilities Impact 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.
Aeeris has total liabilities of AU$397k and total assets of AU$1.2m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Aeeris’s ROCE is concerning.
What We Can Learn From Aeeris’s ROCE
This company may not be the most attractive investment prospect. You might be able to find a better buy than Aeeris. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.