Today we’ll look at Straco Corporation Limited (SGX:S85) 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.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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 Straco:
0.18 = S$65m ÷ (S$390m – S$26m) (Based on the trailing twelve months to June 2019.)
Therefore, Straco has an ROCE of 18%.
Does Straco Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Straco’s ROCE is meaningfully higher than the 4.5% average in the Hospitality industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Straco compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If Straco is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Straco’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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Straco has total assets of S$390m and current liabilities of S$26m. Therefore its current liabilities are equivalent to approximately 6.7% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Straco earns a sound return on capital employed.
Our Take On Straco’s ROCE
If Straco can continue reinvesting in its business, it could be an attractive prospect. Straco 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.
I will like Straco better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.