Today we’ll evaluate K-Bro Linen Inc. (TSE:KBL) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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.’
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 K-Bro Linen:
0.063 = CA$18m ÷ (CA$317m – CA$34m) (Based on the trailing twelve months to September 2018.)
Therefore, K-Bro Linen has an ROCE of 6.3%.
Does K-Bro Linen Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see K-Bro Linen’s ROCE is meaningfully below the Commercial Services industry average of 8.3%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, K-Bro Linen’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
K-Bro Linen’s current ROCE of 6.3% is lower than its ROCE in the past, which was 15%, 3 years ago. So investors might consider if it has had issues recently.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for K-Bro Linen.
What Are Current Liabilities, And How Do They Affect K-Bro Linen’s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
K-Bro Linen has total assets of CA$317m and current liabilities of CA$34m. As a result, its current liabilities are equal to approximately 11% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From K-Bro Linen’s ROCE
If K-Bro Linen continues to earn an uninspiring ROCE, there may be better places to invest. Of course you might be able to find a better stock than K-Bro Linen. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.