Today we’ll evaluate ELUON Corporation (KOSDAQ:065440) 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.
Firstly, 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.
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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 ELUON:
0.076 = ₩3.2b ÷ (₩57b – ₩15b) (Based on the trailing twelve months to September 2019.)
Therefore, ELUON has an ROCE of 7.6%.
Is ELUON’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that ELUON’s ROCE is fairly close to the Software industry average of 6.4%. Setting aside the industry comparison for now, ELUON’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
ELUON reported an ROCE of 7.6% — better than 3 years ago, when the company didn’t make a profit. That suggests the business has returned to profitability. You can see in the image below how ELUON’s ROCE compares to its industry. Click to see more on past growth.
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. You can check if ELUON has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect ELUON’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ELUON has total assets of ₩57b and current liabilities of ₩15b. Therefore its current liabilities are equivalent to approximately 27% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On ELUON’s ROCE
If ELUON continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than ELUON. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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