Today we are going to look at AboCom Systems, Inc. (TPE:2444) 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.
Firstly, 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. In brief, it is a useful tool, but it is not without drawbacks. 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'.
How Do You Calculate Return On Capital Employed?
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 AboCom Systems:
0.016 = NT$15m ÷ (NT$1.7b - NT$766m) (Based on the trailing twelve months to March 2020.)
Therefore, AboCom Systems has an ROCE of 1.6%.
See our latest analysis for AboCom Systems
Does AboCom Systems Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, AboCom Systems's ROCE appears meaningfully below the 8.5% average reported by the Communications industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how AboCom Systems stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
AboCom Systems's current ROCE of 1.6% is lower than 3 years ago, when the company reported a 2.4% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how AboCom Systems's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. You can check if AboCom Systems has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
AboCom Systems's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
AboCom Systems has total assets of NT$1.7b and current liabilities of NT$766m. Therefore its current liabilities are equivalent to approximately 44% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, AboCom Systems's ROCE is concerning.
The Bottom Line On AboCom Systems's ROCE
This company may not be the most attractive investment prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.