Today we'll look at mm2 Asia Ltd. (SGX:1B0) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 mm2 Asia:
0.12 = S$54m ÷ (S$666m - S$196m) (Based on the trailing twelve months to March 2019.)
So, mm2 Asia has an ROCE of 12%.
Does mm2 Asia Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that mm2 Asia's ROCE is meaningfully better than the 5.4% average in the Entertainment industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where mm2 Asia sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
mm2 Asia's current ROCE of 12% is lower than its ROCE in the past, which was 26%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how mm2 Asia's ROCE compares to its industry, and you can click it to see more detail on its 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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do mm2 Asia's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
mm2 Asia has total assets of S$666m and current liabilities of S$196m. As a result, its current liabilities are equal to approximately 29% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On mm2 Asia's ROCE
Overall, mm2 Asia has a decent ROCE and could be worthy of further research. mm2 Asia 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.