Are Ariadne Australia Limited’s Returns On Capital Worth Investigating?
Today we’ll evaluate Ariadne Australia Limited (ASX:ARA) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Ariadne Australia:
0.11 = AU$18m ÷ (AU$172m – AU$7.7m) (Based on the trailing twelve months to December 2018.)
So, Ariadne Australia has an ROCE of 11%.
Check out our latest analysis for Ariadne Australia
Is Ariadne Australia’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Ariadne Australia’s ROCE appears to be around the 12% average of the Commercial Services industry. Separate from Ariadne Australia’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Ariadne Australia has an ROCE of 11%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability.
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, after all, simply a snap shot of a single year. You can check if Ariadne Australia has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Ariadne Australia’s Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Ariadne Australia has total assets of AU$172m and current liabilities of AU$7.7m. Therefore its current liabilities are equivalent to approximately 4.5% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Ariadne Australia earns a sound return on capital employed.
The Bottom Line On Ariadne Australia’s ROCE
If it is able to keep this up, Ariadne Australia could be attractive. Of course you might be able to find a better stock than Ariadne Australia. 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.
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 editorial-team@simplywallst.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.
