Don’t Buy Simple Mart Retail Co., Ltd. (GTSM:2945) Until You Understand Its ROCE

Today we'll evaluate Simple Mart Retail Co., Ltd. (GTSM:2945) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Simple Mart Retail:

0.073 = NT$173m ÷ (NT$4.7b - NT$2.3b) (Based on the trailing twelve months to June 2019.)

So, Simple Mart Retail has an ROCE of 7.3%.

Check out our latest analysis for Simple Mart Retail

Does Simple Mart Retail Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. It appears that Simple Mart Retail's ROCE is fairly close to the Multiline Retail industry average of 6.1%. Separate from how Simple Mart Retail stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

You can see in the image below how Simple Mart Retail's ROCE compares to its industry. Click to see more on past growth.

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 only a point-in-time measure. How cyclical is Simple Mart Retail? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Simple Mart Retail's 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Simple Mart Retail has total liabilities of NT$2.3b and total assets of NT$4.7b. Therefore its current liabilities are equivalent to approximately 49% of its total assets. Simple Mart Retail's middling level of current liabilities have the effect of boosting its ROCE a bit.

What We Can Learn From Simple Mart Retail's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might also be able to find a better stock than Simple Mart Retail. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Simple Mart Retail better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.