Today we’ll look at Ship Finance International Limited (NYSE:SFL) and reflect on its potential as an investment. 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.
What is 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
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 Ship Finance International:
0.048 = US$167m ÷ (US$3.9b – US$404m) (Based on the trailing twelve months to December 2018.)
So, Ship Finance International has an ROCE of 4.8%.
Does Ship Finance International Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Ship Finance International’s ROCE is fairly close to the Shipping industry average of 4.8%. Independently of how Ship Finance International compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Ship Finance International’s current ROCE of 4.8% is lower than its ROCE in the past, which was 7.2%, 3 years ago. So investors might consider if it has had issues recently.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ship Finance International.
Do Ship Finance International’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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Ship Finance International has total assets of US$3.9b and current liabilities of US$404m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Ship Finance International’s ROCE
Ship Finance International has a poor ROCE, and there may be better investment prospects out there. Of course you might be able to find a better stock than Ship Finance International. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.