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Today we are going to look at AWF Madison Group Limited (NZSE:AWF) to see whether it might be an attractive investment prospect. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its 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.'
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 AWF Madison Group:
0.06 = NZ$4.2m ÷ (NZ$96m - NZ$25m) (Based on the trailing twelve months to March 2019.)
Therefore, AWF Madison Group has an ROCE of 6.0%.
View our latest analysis for AWF Madison Group
Is AWF Madison Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see AWF Madison Group's ROCE is meaningfully below the Professional Services industry average of 18%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how AWF Madison Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
As we can see, AWF Madison Group currently has an ROCE of 6.0%, less than the 16% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
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 only a point-in-time measure. You can check if AWF Madison Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
AWF Madison Group'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
AWF Madison Group has total liabilities of NZ$25m and total assets of NZ$96m. As a result, its current liabilities are equal to approximately 26% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On AWF Madison Group's ROCE
If AWF Madison Group continues to earn an uninspiring ROCE, there may be better places to invest. 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 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 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.