Today we’ll look at Sterling Construction Company, Inc. (NASDAQ:STRL) and reflect on its potential as an investment. 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. 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. 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 Sterling Construction Company:
0.099 = US$18m ÷ (US$494m – US$195m) (Based on the trailing twelve months to September 2018.)
So, Sterling Construction Company has an ROCE of 9.9%.
Does Sterling Construction Company Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Sterling Construction Company’s ROCE is around the 10% average reported by the Construction industry. Aside from the industry comparison, Sterling Construction Company’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.
Sterling Construction Company reported an ROCE of 9.9% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Sterling Construction Company’s 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Sterling Construction Company has total liabilities of US$195m and total assets of US$494m. As a result, its current liabilities are equal to approximately 39% of its total assets. Sterling Construction Company’s middling level of current liabilities have the effect of boosting its ROCE a bit.
The Bottom Line On Sterling Construction Company’s ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better buy than Sterling Construction Company. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.