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Is Aurizon Holdings Limited's (ASX:AZJ) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we'll look at Aurizon Holdings Limited (ASX:AZJ) and reflect on its potential as an investment. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

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 Aurizon Holdings:

0.10 = AU$895m ÷ (AU$9.6b - AU$810m) (Based on the trailing twelve months to December 2018.)

So, Aurizon Holdings has an ROCE of 10%.

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Does Aurizon Holdings Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Aurizon Holdings's ROCE is around the 10% average reported by the Transportation industry. Aside from the industry comparison, Aurizon Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

ASX:AZJ Past Revenue and Net Income, May 25th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Aurizon Holdings's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Aurizon Holdings has total liabilities of AU$810m and total assets of AU$9.6b. As a result, its current liabilities are equal to approximately 8.4% of its total assets. Aurizon Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

What We Can Learn From Aurizon Holdings's ROCE

Based on this information, Aurizon Holdings appears to be a mediocre business. But note: make sure you look for a great company, not just the first idea you come across. 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.