Today we'll evaluate Mirach Energy Limited (SGX:AWO) 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 of all, we'll work out how to 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.
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. 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.
So, How Do We Calculate ROCE?
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 Mirach Energy:
0.48 = US$3.9m ÷ (US$20m - US$12m) (Based on the trailing twelve months to September 2019.)
Therefore, Mirach Energy has an ROCE of 48%.
Is Mirach Energy's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Mirach Energy's ROCE is meaningfully better than the 8.3% average in the Oil and Gas industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Mirach Energy's ROCE currently appears to be excellent.
Mirach Energy has an ROCE of 48%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Mirach Energy's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. We note Mirach Energy could be considered a cyclical business. You can check if Mirach Energy has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Mirach Energy'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Mirach Energy has current liabilities of US$12m and total assets of US$20m. As a result, its current liabilities are equal to approximately 59% of its total assets. While a high level of current liabilities boosts its ROCE, Mirach Energy's returns are still very good.
Our Take On Mirach Energy's ROCE
So to us, the company is potentially worth investigating further. Mirach Energy 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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