Today we’ll look at ATA Inc. (NASDAQ:ATAI) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. 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. 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?
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 ATA:
0.27 = CN¥93m ÷ (CN¥366m – CN¥34m) (Based on the trailing twelve months to September 2018.)
Therefore, ATA has an ROCE of 27%.
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Is ATA’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, ATA’s ROCE is meaningfully higher than the 11% average in the Consumer Services industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, ATA’s ROCE in absolute terms currently looks quite high.
In our analysis, ATA’s ROCE appears to be 27%, compared to 3 years ago, when its ROCE was 3.2%. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is ATA? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How ATA’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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
ATA has total liabilities of CN¥34m and total assets of CN¥366m. As a result, its current liabilities are equal to approximately 9.2% of its total assets. Modest current liabilities are not boosting ATA’s very nice ROCE.
What We Can Learn From ATA’s ROCE
This is an attractive combination and suggests the company could have potential. You might be able to find a better buy than ATA. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 email@example.com.