Today we'll evaluate Ageson Berhad (KLSE:PSIPTEK) 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. 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 Ageson Berhad:
0.065 = RM15m ÷ (RM313m - RM82m) (Based on the trailing twelve months to December 2019.)
Therefore, Ageson Berhad has an ROCE of 6.5%.
Is Ageson Berhad's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Ageson Berhad's ROCE appears to be around the 6.8% average of the Construction industry. Aside from the industry comparison, Ageson Berhad'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.
In our analysis, Ageson Berhad's ROCE appears to be 6.5%, compared to 3 years ago, when its ROCE was 5.0%. This makes us wonder if the company is improving. You can see in the image below how Ageson Berhad's ROCE compares to its industry. Click to see more on past growth.
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, after all, simply a snap shot of a single year. You can check if Ageson Berhad has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Ageson Berhad'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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Ageson Berhad has current liabilities of RM82m and total assets of RM313m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Ageson Berhad's ROCE
If Ageson Berhad continues to earn an uninspiring ROCE, there may be better places to invest. 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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. Thank you for reading.
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