Today we'll look at Academies Australasia Group Limited (ASX:AKG) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Academies Australasia Group:
0.20 = AU$8.0m ÷ (AU$70m - AU$29m) (Based on the trailing twelve months to June 2019.)
So, Academies Australasia Group has an ROCE of 20%.
Is Academies Australasia Group's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Academies Australasia Group's ROCE is meaningfully higher than the 9.2% average in the Consumer Services industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Academies Australasia Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Academies Australasia Group delivered an ROCE of 20%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can click on the image below to see (in greater detail) how Academies Australasia Group's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Academies Australasia Group is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Academies Australasia Group's Current Liabilities Impact 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.
Academies Australasia Group has total liabilities of AU$29m and total assets of AU$70m. As a result, its current liabilities are equal to approximately 41% of its total assets. Academies Australasia Group has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On Academies Australasia Group's ROCE
Academies Australasia Group's ROCE does look good, but the level of current liabilities also contribute to that. Academies Australasia Group 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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. Thank you for reading.