Here’s why Kew Media Group Inc.’s (TSE:KEW) Returns On Capital Matters So Much

Today we’ll evaluate Kew Media Group Inc. (TSE:KEW) to determine whether it could have potential as an investment idea. 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. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. 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?

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 Kew Media Group:

0.055 = CA$14m ÷ (CA$414m – CA$160m) (Based on the trailing twelve months to December 2018.)

Therefore, Kew Media Group has an ROCE of 5.5%.

Check out our latest analysis for Kew Media Group

Is Kew Media Group’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Kew Media Group’s ROCE appears to be significantly below the 9.5% average in the Entertainment industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Kew Media Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

TSX:KEW Past Revenue and Net Income, April 17th 2019
TSX:KEW Past Revenue and Net Income, April 17th 2019

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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Kew Media Group.

What Are Current Liabilities, And How Do They Affect Kew Media Group’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Kew Media Group has total liabilities of CA$160m and total assets of CA$414m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. Kew Media Group has a medium level of current liabilities, which would boost its ROCE somewhat.

Our Take On Kew Media Group’s ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.