Today we'll look at Monadelphous Group Limited (ASX:MND) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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'.
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 Monadelphous Group:
0.21 = AU$86m ÷ (AU$670m - AU$252m) (Based on the trailing twelve months to December 2018.)
Therefore, Monadelphous Group has an ROCE of 21%.
Is Monadelphous Group's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Monadelphous Group's ROCE appears to be around the 20% average of the Construction industry. Setting aside the comparison to its industry for a moment, Monadelphous Group's ROCE in absolute terms currently looks quite high.
Monadelphous Group's current ROCE of 21% is lower than its ROCE in the past, which was 30%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Monadelphous Group.
Do Monadelphous Group'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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Monadelphous Group has total assets of AU$670m and current liabilities of AU$252m. As a result, its current liabilities are equal to approximately 38% of its total assets. Monadelphous Group has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From Monadelphous Group's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Monadelphous Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.