Today we are going to look at Advance NanoTek Limited (ASX:ANO) 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.
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 Advance NanoTek:
0.17 = AU$3.2m ÷ (AU$20m - AU$817k) (Based on the trailing twelve months to June 2019.)
Therefore, Advance NanoTek has an ROCE of 17%.
Does Advance NanoTek Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Advance NanoTek's ROCE appears to be substantially greater than the 13% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Advance NanoTek sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Advance NanoTek delivered an ROCE of 17%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Advance NanoTek's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. If Advance NanoTek is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Advance NanoTek'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.
Advance NanoTek has total assets of AU$20m and current liabilities of AU$817k. Therefore its current liabilities are equivalent to approximately 4.1% of its total assets. Low current liabilities have only a minimal impact on Advance NanoTek's ROCE, making its decent returns more credible.
The Bottom Line On Advance NanoTek's ROCE
If it is able to keep this up, Advance NanoTek could be attractive. Advance NanoTek looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
Advance NanoTek is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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.
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.