Today we'll look at Japfa Ltd. (SGX:UD2) 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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?
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 Japfa:
0.14 = US$296m ÷ (US$3.1b - US$1.0b) (Based on the trailing twelve months to June 2019.)
So, Japfa has an ROCE of 14%.
Does Japfa Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Japfa's ROCE appears to be substantially greater than the 8.6% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Japfa compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Japfa's current ROCE of 14% is lower than its ROCE in the past, which was 19%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Japfa's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Japfa.
What Are Current Liabilities, And How Do They Affect Japfa's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Japfa has total liabilities of US$1.0b and total assets of US$3.1b. As a result, its current liabilities are equal to approximately 32% of its total assets. Japfa has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Japfa's ROCE
Japfa's ROCE does look good, but the level of current liabilities also contribute to that. Japfa 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.
I will like Japfa better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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