Today we are going to look at Alpha Pro Tech, Ltd. (NYSEMKT:APT) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. In brief, it is a useful tool, but it is not without drawbacks. 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'.
So, How Do We Calculate ROCE?
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 Alpha Pro Tech:
0.11 = US$4.0m ÷ (US$38m - US$2.1m) (Based on the trailing twelve months to June 2019.)
Therefore, Alpha Pro Tech has an ROCE of 11%.
Is Alpha Pro Tech's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Alpha Pro Tech's ROCE is fairly close to the Building industry average of 12%. Separate from Alpha Pro Tech's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Alpha Pro Tech's ROCE appears to be 11%, compared to 3 years ago, when its ROCE was 7.9%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Alpha Pro Tech's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Alpha Pro Tech has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Alpha Pro Tech's Current Liabilities Impact 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. 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.
Alpha Pro Tech has total liabilities of US$2.1m and total assets of US$38m. As a result, its current liabilities are equal to approximately 5.5% of its total assets. Low current liabilities have only a minimal impact on Alpha Pro Tech's ROCE, making its decent returns more credible.
The Bottom Line On Alpha Pro Tech's ROCE
This is good to see, and while better prospects may exist, Alpha Pro Tech seems worth researching further. Alpha Pro Tech 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 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. Thank you for reading.