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Today we'll evaluate Saferoads Holdings Limited (ASX:SRH) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Saferoads Holdings:
0.088 = AU$910k ÷ (AU$14m - AU$3.5m) (Based on the trailing twelve months to December 2018.)
Therefore, Saferoads Holdings has an ROCE of 8.8%.
Is Saferoads Holdings's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Saferoads Holdings's ROCE appears to be around the 9.6% average of the Electronic industry. Setting aside the industry comparison for now, Saferoads 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.
Our data shows that Saferoads Holdings currently has an ROCE of 8.8%, compared to its ROCE of 1.8% 3 years ago. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. You can check if Saferoads Holdings has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Saferoads Holdings's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Saferoads Holdings has total assets of AU$14m and current liabilities of AU$3.5m. As a result, its current liabilities are equal to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Saferoads Holdings's ROCE
That said, Saferoads Holdings's ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Saferoads Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Saferoads Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.