Today we'll evaluate Chemical Industries (Far East) Limited (SGX:C05) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Chemical Industries (Far East):
0.025 = S$3.1m ÷ (S$130m - S$9.4m) (Based on the trailing twelve months to March 2019.)
Therefore, Chemical Industries (Far East) has an ROCE of 2.5%.
Does Chemical Industries (Far East) Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Chemical Industries (Far East)'s ROCE is meaningfully below the Chemicals industry average of 5.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Chemical Industries (Far East) compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.3% available in government bonds. Readers may wish to look for more rewarding investments.
Chemical Industries (Far East)'s current ROCE of 2.5% is lower than its ROCE in the past, which was 7.0%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Chemical Industries (Far East)'s past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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, after all, simply a snap shot of a single year. If Chemical Industries (Far East) is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Chemical Industries (Far East)'s 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Chemical Industries (Far East) has total assets of S$130m and current liabilities of S$9.4m. Therefore its current liabilities are equivalent to approximately 7.2% of its total assets. Chemical Industries (Far East) has very few current liabilities, which have a minimal effect on its already low ROCE.
The Bottom Line On Chemical Industries (Far East)'s ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course, you might also be able to find a better stock than Chemical Industries (Far East). So you may wish to see this free collection of other companies that have grown earnings strongly.
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.