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Here's What DIRTT Environmental Solutions Ltd.'s (TSE:DRT) ROCE Can Tell Us

Simply Wall St

Today we'll look at DIRTT Environmental Solutions Ltd. (TSE:DRT) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 DIRTT Environmental Solutions:

0.17 = US$25m ÷ (US$186m - US$39m) (Based on the trailing twelve months to September 2019.)

So, DIRTT Environmental Solutions has an ROCE of 17%.

Check out our latest analysis for DIRTT Environmental Solutions

Does DIRTT Environmental Solutions Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. DIRTT Environmental Solutions's ROCE appears to be substantially greater than the 13% average in the Building 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 DIRTT Environmental Solutions sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

We can see that, DIRTT Environmental Solutions currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 7.5%. This makes us wonder if the company is improving. You can see in the image below how DIRTT Environmental Solutions's ROCE compares to its industry. Click to see more on past growth.

TSX:DRT Past Revenue and Net Income, January 12th 2020

It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for DIRTT Environmental Solutions.

Do DIRTT Environmental Solutions's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

DIRTT Environmental Solutions has total assets of US$186m and current liabilities of US$39m. As a result, its current liabilities are equal to approximately 21% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On DIRTT Environmental Solutions's ROCE

Overall, DIRTT Environmental Solutions has a decent ROCE and could be worthy of further research. DIRTT Environmental Solutions shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.