Today we are going to look at J. Smart & Co. (Contractors) PLC (LON:SMJ) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. 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. 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 J. Smart (Contractors):
0.015 = UK£1.5m ÷ (UK£116m – UK£17m) (Based on the trailing twelve months to January 2019.)
Therefore, J. Smart (Contractors) has an ROCE of 1.5%.
Does J. Smart (Contractors) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see J. Smart (Contractors)’s ROCE is meaningfully below the Construction industry average of 19%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how J. Smart (Contractors) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.2% available in government bonds. Readers may wish to look for more rewarding investments.
J. Smart (Contractors)’s current ROCE of 1.5% is lower than its ROCE in the past, which was 2.6%, 3 years ago. So investors might consider if it has had issues recently.
When considering this metric, keep in mind that it is backwards looking, and 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. How cyclical is J. Smart (Contractors)? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
J. Smart (Contractors)’s Current Liabilities And Their Impact On 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.
J. Smart (Contractors) has total assets of UK£116m and current liabilities of UK£17m. As a result, its current liabilities are equal to approximately 15% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On J. Smart (Contractors)’s ROCE
While that is good to see, J. Smart (Contractors) has a low ROCE and does not look attractive in this analysis. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like J. Smart (Contractors) better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 firstname.lastname@example.org. 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.