Today we'll look at BSA Limited (ASX:BSA) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 BSA:
0.36 = AU$16m ÷ (AU$150m - AU$107m) (Based on the trailing twelve months to June 2019.)
So, BSA has an ROCE of 36%.
Is BSA's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that BSA's ROCE is meaningfully better than the 14% average in the Commercial Services 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. Regardless of the industry comparison, in absolute terms, BSA's ROCE currently appears to be excellent.
In our analysis, BSA's ROCE appears to be 36%, compared to 3 years ago, when its ROCE was 28%. This makes us think the business might be improving. You can see in the image below how BSA's ROCE compares to its industry. Click to see more on past growth.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for BSA.
BSA's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
BSA has total assets of AU$150m and current liabilities of AU$107m. As a result, its current liabilities are equal to approximately 71% of its total assets. While a high level of current liabilities boosts its ROCE, BSA's returns are still very good.
Our Take On BSA's ROCE
In my book, this business could be worthy of further research. BSA 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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