Today we'll evaluate CEI Limited (SGX:AVV) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding 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. In general, businesses with a higher ROCE are usually better quality. 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.
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 CEI:
0.19 = S$8.4m ÷ (S$71m - S$27m) (Based on the trailing twelve months to December 2019.)
Therefore, CEI has an ROCE of 19%.
Is CEI's ROCE Good?
One way to assess ROCE is to compare similar companies. CEI's ROCE appears to be substantially greater than the 10.0% average in the Electronic 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 where CEI sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how CEI's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. If CEI is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How CEI's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
CEI has current liabilities of S$27m and total assets of S$71m. As a result, its current liabilities are equal to approximately 38% of its total assets. CEI has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On CEI's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. CEI 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.
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.
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