Should You Like Kelso Technologies Inc.’s (TSE:KLS) High Return On Capital Employed?
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Today we'll evaluate Kelso Technologies Inc. (TSE:KLS) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared 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. All else being equal, a better business will have a higher ROCE. 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?
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 Kelso Technologies:
0.23 = US$2.2m ÷ (US$12m - US$2.7m) (Based on the trailing twelve months to March 2019.)
So, Kelso Technologies has an ROCE of 23%.
See our latest analysis for Kelso Technologies
Is Kelso Technologies's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Kelso Technologies's ROCE is meaningfully higher than the 9.3% average in the Machinery 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, Kelso Technologies's ROCE is currently very good.
Kelso Technologies has an ROCE of 23%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.
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 Kelso Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Kelso Technologies's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Kelso Technologies has total assets of US$12m and current liabilities of US$2.7m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Kelso Technologies's ROCE
Low current liabilities and high ROCE is a good combination, making Kelso Technologies look quite interesting. 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.
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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 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. Thank you for reading.
