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Today we’ll look at Aquatech S.A. (WSE:AQT) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
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 Aquatech:
0.46 = zł4.5m ÷ (zł15m – zł4.9m) (Based on the trailing twelve months to March 2019.)
So, Aquatech has an ROCE of 46%.
Does Aquatech Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Aquatech’s ROCE is meaningfully higher than the 8.2% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Aquatech’s ROCE in absolute terms currently looks quite high.
In our analysis, Aquatech’s ROCE appears to be 46%, compared to 3 years ago, when its ROCE was 5.9%. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. If Aquatech is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Aquatech’s Current Liabilities Skew Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Aquatech has total liabilities of zł4.9m and total assets of zł15m. As a result, its current liabilities are equal to approximately 33% of its total assets. A medium level of current liabilities boosts Aquatech’s ROCE somewhat.
The Bottom Line On Aquatech’s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Aquatech shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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. Thank you for reading.