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Today we'll evaluate Straco Corporation Limited (SGX:S85) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Straco:
0.17 = S$66m ÷ (S$414m - S$25m) (Based on the trailing twelve months to March 2019.)
Therefore, Straco has an ROCE of 17%.
Does Straco Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Straco's ROCE is meaningfully better than the 5.4% average in the Hospitality 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. Separate from Straco's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Straco's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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 only a point-in-time measure. How cyclical is Straco? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How Straco's Current Liabilities Impact 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.
Straco has total liabilities of S$25m and total assets of S$414m. As a result, its current liabilities are equal to approximately 6.0% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), Straco earns a sound return on capital employed.
Our Take On Straco's ROCE
This is good to see, and while better prospects may exist, Straco seems worth researching further. There might be better investments than Straco 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.
I will like Straco better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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.