Today we are going to look at ATA Inc. (NASDAQ:ATAI) to see whether it might be an attractive investment prospect. 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. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 ATA:
0.27 = CN¥93m ÷ (CN¥366m – CN¥34m) (Based on the trailing twelve months to September 2018.)
Therefore, ATA has an ROCE of 27%.
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Does ATA Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, ATA’s ROCE is meaningfully higher than the 11% average in the Consumer Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, ATA’s ROCE currently appears to be excellent.
In our analysis, ATA’s ROCE appears to be 27%, compared to 3 years ago, when its ROCE was 3.2%. This makes us think the business might be improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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 ATA is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How ATA’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. 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.
ATA has total liabilities of CN¥34m and total assets of CN¥366m. As a result, its current liabilities are equal to approximately 9.2% of its total assets. Minimal current liabilities are not distorting ATA’s impressive ROCE.
What We Can Learn From ATA’s ROCE
This suggests the company would be worth researching in more depth. 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.
I will like ATA better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.