Today we are going to look at Austin Engineering Limited (ASX:ANG) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Austin Engineering:
0.11 = AU$12m ÷ (AU$177m - AU$70m) (Based on the trailing twelve months to June 2019.)
Therefore, Austin Engineering has an ROCE of 11%.
Does Austin Engineering Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Austin Engineering's ROCE appears to be around the 9.3% average of the Machinery industry. Regardless of where Austin Engineering sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Austin Engineering 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. The image below shows how Austin Engineering's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Austin Engineering.
How Austin Engineering's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Austin Engineering has total assets of AU$177m and current liabilities of AU$70m. Therefore its current liabilities are equivalent to approximately 40% of its total assets. Austin Engineering has a middling amount of current liabilities, increasing its ROCE somewhat.
What We Can Learn From Austin Engineering's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Austin Engineering 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).
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 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.