Today we are going to look at Cortina Holdings Limited (SGX:C41) 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 up, we'll look at what ROCE is and how we calculate it. 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Cortina Holdings:
0.19 = S$50m ÷ (S$337m - S$80m) (Based on the trailing twelve months to September 2019.)
Therefore, Cortina Holdings has an ROCE of 19%.
See our latest analysis for Cortina Holdings
Does Cortina Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that Cortina Holdings's ROCE is meaningfully better than the 10% average in the Specialty Retail industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Cortina Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Cortina Holdings currently has an ROCE of 19%, compared to its ROCE of 11% 3 years ago. This makes us wonder if the company is improving. The image below shows how Cortina Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. You can check if Cortina Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Cortina Holdings's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Cortina Holdings has total assets of S$337m and current liabilities of S$80m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Cortina Holdings's ROCE
With that in mind, Cortina Holdings's ROCE appears pretty good. Cortina Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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.