Today we'll evaluate ALS Limited (ASX:ALQ) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
So, How Do We Calculate ROCE?
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 ALS:
0.13 = AU$291m ÷ (AU$2.6b - AU$345m) (Based on the trailing twelve months to September 2019.)
So, ALS has an ROCE of 13%.
Is ALS's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, ALS's ROCE appears to be significantly below the 18% average in the Professional Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from ALS's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, ALS's ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 8.4%. This makes us wonder if the company is improving. The image below shows how ALS's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How ALS'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.
ALS has total liabilities of AU$345m and total assets of AU$2.6b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From ALS's ROCE
Overall, ALS has a decent ROCE and could be worthy of further research. There might be better investments than ALS out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like ALS better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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