Today we'll look at Silverlake Axis Ltd (SGX:5CP) 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. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Silverlake Axis:
0.26 = RM247m ÷ (RM1.2b - RM240m) (Based on the trailing twelve months to March 2019.)
Therefore, Silverlake Axis has an ROCE of 26%.
Is Silverlake Axis's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Silverlake Axis's ROCE is meaningfully better than the 10% average in the Software industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Silverlake Axis's ROCE is currently very good.
Silverlake Axis's current ROCE of 26% is lower than 3 years ago, when the company reported a 44% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Silverlake Axis's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Silverlake Axis's 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Silverlake Axis has total liabilities of RM240m and total assets of RM1.2b. As a result, its current liabilities are equal to approximately 20% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
The Bottom Line On Silverlake Axis's ROCE
This is good to see, and with such a high ROCE, Silverlake Axis may be worth a closer look. Silverlake Axis 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.
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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.