Today we'll evaluate First Resources Limited (SGX:EB5) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding 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. 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.
So, How Do We Calculate ROCE?
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 First Resources:
0.11 = US$155m ÷ (US$1.7b - US$314m) (Based on the trailing twelve months to December 2019.)
So, First Resources has an ROCE of 11%.
Is First Resources's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, First Resources's ROCE is meaningfully higher than the 8.5% average in the Food industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how First Resources compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, First Resources currently has an ROCE of 11%, less than the 16% it reported 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 First Resources's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for First Resources.
Do First Resources's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
First Resources has current liabilities of US$314m and total assets of US$1.7b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On First Resources's ROCE
This is good to see, and with a sound ROCE, First Resources could be worth a closer look. First Resources looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.