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Today we'll evaluate Micro-Mechanics (Holdings) Ltd. (SGX:5DD) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Micro-Mechanics (Holdings):
0.30 = S$18m ÷ (S$67m - S$6.9m) (Based on the trailing twelve months to March 2019.)
So, Micro-Mechanics (Holdings) has an ROCE of 30%.
Does Micro-Mechanics (Holdings) Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Micro-Mechanics (Holdings)'s ROCE appears to be substantially greater than the 5.8% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Micro-Mechanics (Holdings)'s ROCE in absolute terms currently looks quite high.
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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Micro-Mechanics (Holdings).
Do Micro-Mechanics (Holdings)'s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Micro-Mechanics (Holdings) has total liabilities of S$6.9m and total assets of S$67m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
What We Can Learn From Micro-Mechanics (Holdings)'s ROCE
This is good to see, and with such a high ROCE, Micro-Mechanics (Holdings) may be worth a closer look. Micro-Mechanics (Holdings) 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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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 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. Thank you for reading.