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Here's What Kelso Technologies Inc.'s (TSE:KLS) ROCE Can Tell Us

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Today we'll evaluate Kelso Technologies Inc. (TSE:KLS) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its 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.

How Do You Calculate Return On Capital Employed?

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 Kelso Technologies:

0.32 = US$3.3m ÷ (US$12m - US$2.1m) (Based on the trailing twelve months to September 2019.)

Therefore, Kelso Technologies has an ROCE of 32%.

Check out our latest analysis for Kelso Technologies

Does Kelso Technologies Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Using our data, we find that Kelso Technologies's ROCE is meaningfully better than the 9.7% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Kelso Technologies's ROCE currently appears to be excellent.

Kelso Technologies reported an ROCE of 32% -- better than 3 years ago, when the company didn't make a profit. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Kelso Technologies's past growth compares to other companies.

TSX:KLS Past Revenue and Net Income, January 13th 2020
TSX:KLS Past Revenue and Net Income, January 13th 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Kelso Technologies is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do Kelso Technologies's Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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.

Kelso Technologies has total liabilities of US$2.1m and total assets of US$12m. As a result, its current liabilities are equal to approximately 17% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.

The Bottom Line On Kelso Technologies's ROCE

, There might be better investments than Kelso Technologies out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.