Today we'll look at HG Metal Manufacturing Limited (SGX:BTG) and reflect on its potential as an investment. 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 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the 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 HG Metal Manufacturing:
0.0041 = S$468k ÷ (S$173m - S$58m) (Based on the trailing twelve months to December 2019.)
Therefore, HG Metal Manufacturing has an ROCE of 0.4%.
Is HG Metal Manufacturing's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, HG Metal Manufacturing's ROCE appears meaningfully below the 2.9% average reported by the Trade Distributors industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how HG Metal Manufacturing stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
HG Metal Manufacturing reported an ROCE of 0.4% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. You can see in the image below how HG Metal Manufacturing'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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is HG Metal Manufacturing? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How HG Metal Manufacturing's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.
HG Metal Manufacturing has current liabilities of S$58m and total assets of S$173m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, HG Metal Manufacturing's ROCE is concerning.
The Bottom Line On HG Metal Manufacturing's ROCE
So researching other companies may be a better use of your time. Of course, you might also be able to find a better stock than HG Metal Manufacturing. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
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