Today we are going to look at Hi-Clearance Inc. (GTSM:1788) to see whether it might be an attractive investment prospect. 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, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Hi-Clearance:
0.12 = NT$309m ÷ (NT$3.5b – NT$904m) (Based on the trailing twelve months to September 2019.)
Therefore, Hi-Clearance has an ROCE of 12%.
Is Hi-Clearance’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Hi-Clearance’s ROCE appears to be around the 10.0% average of the Healthcare industry. Regardless of where Hi-Clearance sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Hi-Clearance’s current ROCE of 12% is lower than its ROCE in the past, which was 16%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Hi-Clearance’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 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. If Hi-Clearance is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Hi-Clearance’s Current Liabilities Impact 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Hi-Clearance has total assets of NT$3.5b and current liabilities of NT$904m. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Hi-Clearance’s ROCE
This is good to see, and with a sound ROCE, Hi-Clearance could be worth a closer look. Hi-Clearance 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 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 firstname.lastname@example.org. 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.
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