Today we'll look at Ashley Services Group Limited (ASX:ASH) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Ashley Services Group:
0.28 = AU$8.1m ÷ (AU$45m - AU$17m) (Based on the trailing twelve months to June 2019.)
Therefore, Ashley Services Group has an ROCE of 28%.
Does Ashley Services Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Ashley Services Group's ROCE appears to be substantially greater than the 18% average in the Professional Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Ashley Services Group's ROCE currently appears to be excellent.
Ashley Services Group has an ROCE of 28%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. The image below shows how Ashley Services Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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, after all, simply a snap shot of a single year. How cyclical is Ashley Services Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Ashley Services Group's Current Liabilities And Their Impact On 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.
Ashley Services Group has total assets of AU$45m and current liabilities of AU$17m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. Ashley Services Group's ROCE is boosted somewhat by its middling amount of current liabilities.
Our Take On Ashley Services Group's ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. There might be better investments than Ashley Services Group 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 Ashley Services Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.