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Today we’ll evaluate Alpha Pro Tech, Ltd. (NYSEMKT:APT) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into 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 measures the amount of pre-tax profits a company can generate from the capital employed 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?
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 Alpha Pro Tech:
0.11 = US$2.9m ÷ (US$34m – US$1.7m) (Based on the trailing twelve months to September 2018.)
Therefore, Alpha Pro Tech has an ROCE of 11%.
Does Alpha Pro Tech Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Alpha Pro Tech’s ROCE is meaningfully below the Building industry average of 14%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Alpha Pro Tech stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
As we can see, Alpha Pro Tech currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 4.7%. This makes us wonder if the company is improving.
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. ROCE is only a point-in-time measure. How cyclical is Alpha Pro Tech? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Alpha Pro Tech’s Current Liabilities Impact 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. 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.
Alpha Pro Tech has total liabilities of US$1.7m and total assets of US$34m. As a result, its current liabilities are equal to approximately 5.1% of its total assets. With low levels of current liabilities, at least Alpha Pro Tech’s mediocre ROCE is not unduly boosted.
The Bottom Line On Alpha Pro Tech’s ROCE
Alpha Pro Tech looks like an ok business, but on this analysis it is not at the top of our buy list. But note: Alpha Pro Tech may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.