Today we'll evaluate Bisalloy Steel Group Limited (ASX:BIS) 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. Finally, we'll look at how its current liabilities affect 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?
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 Bisalloy Steel Group:
0.14 = AU$5.2m ÷ (AU$77m - AU$39m) (Based on the trailing twelve months to June 2019.)
Therefore, Bisalloy Steel Group has an ROCE of 14%.
Is Bisalloy Steel Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Bisalloy Steel Group's ROCE is meaningfully better than the 8.0% average in the Metals and Mining industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Bisalloy Steel Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Bisalloy Steel Group's ROCE appears to be 14%, compared to 3 years ago, when its ROCE was 7.0%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Bisalloy Steel Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. We note Bisalloy Steel Group could be considered a cyclical business. You can check if Bisalloy Steel Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
How Bisalloy Steel Group's Current Liabilities Impact 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Bisalloy Steel Group has total liabilities of AU$39m and total assets of AU$77m. As a result, its current liabilities are equal to approximately 51% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From Bisalloy Steel Group's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Bisalloy Steel Group 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.
I will like Bisalloy Steel Group 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.