Today we'll look at ISDN Holdings Limited (SGX:I07) 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 up, we'll look at what ROCE is and how we calculate it. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?
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 ISDN Holdings:
0.10 = S$21m ÷ (S$288m - S$83m) (Based on the trailing twelve months to September 2019.)
Therefore, ISDN Holdings has an ROCE of 10%.
Is ISDN Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. ISDN Holdings's ROCE appears to be substantially greater than the 7.8% average in the Electrical industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from ISDN Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how ISDN Holdings's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. You can check if ISDN Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do ISDN Holdings's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
ISDN Holdings has current liabilities of S$83m and total assets of S$288m. As a result, its current liabilities are equal to approximately 29% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On ISDN Holdings's ROCE
This is good to see, and with a sound ROCE, ISDN Holdings could be worth a closer look. ISDN Holdings 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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