Today we'll evaluate Acme United Corporation (NYSEMKT:ACU) 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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'.
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 Acme United:
0.09 = US$8.4m ÷ (US$111m - US$17m) (Based on the trailing twelve months to December 2019.)
Therefore, Acme United has an ROCE of 9.0%.
Does Acme United Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Acme United's ROCE is fairly close to the Commercial Services industry average of 9.1%. Separate from how Acme United stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
You can click on the image below to see (in greater detail) how Acme United'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Acme United? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Acme United'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Acme United has total assets of US$111m and current liabilities of US$17m. As a result, its current liabilities are equal to approximately 15% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Acme United's ROCE
If Acme United continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Acme United. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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