Today we are going to look at Cervus Equipment Corporation (TSE:CERV) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. 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.’
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 Cervus Equipment:
0.11 = CA$42m ÷ (CA$664m – CA$283m) (Based on the trailing twelve months to March 2019.)
Therefore, Cervus Equipment has an ROCE of 11%.
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Is Cervus Equipment’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Cervus Equipment’s ROCE appears to be around the 12% average of the Trade Distributors industry. Separate from Cervus Equipment’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Cervus Equipment’s Current Liabilities Impact 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 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.
Cervus Equipment has total liabilities of CA$283m and total assets of CA$664m. Therefore its current liabilities are equivalent to approximately 43% of its total assets. Cervus Equipment has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Cervus Equipment’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Cervus Equipment looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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 editorial-team@simplywallst.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.