Today we'll evaluate Austal Limited (ASX:ASB) 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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?
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 Austal:
0.094 = AU$81m ÷ (AU$1.3b - AU$475m) (Based on the trailing twelve months to June 2019.)
So, Austal has an ROCE of 9.4%.
Is Austal's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Austal's ROCE appears to be around the 9.4% average of the Aerospace & Defense industry. Regardless of where Austal sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Austal delivered an ROCE of 9.4%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how Austal's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Austal.
What Are Current Liabilities, And How Do They Affect Austal's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Austal has current liabilities of AU$475m and total assets of AU$1.3b. As a result, its current liabilities are equal to approximately 36% of its total assets. Austal has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Austal's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Austal shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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