Today we'll evaluate Acrow Formwork and Construction Services Limited (ASX:ACF) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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.
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 Acrow Formwork and Construction Services:
0.089 = AU$5.1m ÷ (AU$75m - AU$18m) (Based on the trailing twelve months to June 2019.)
So, Acrow Formwork and Construction Services has an ROCE of 8.9%.
Is Acrow Formwork and Construction Services's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Acrow Formwork and Construction Services's ROCE is fairly close to the Trade Distributors industry average of 8.4%. Setting aside the industry comparison for now, Acrow Formwork and Construction Services's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Acrow Formwork and Construction Services has an ROCE of 8.9%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. You can see in the image below how Acrow Formwork and Construction Services's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Acrow Formwork and Construction Services's Current Liabilities Impact 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 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.
Acrow Formwork and Construction Services has total assets of AU$75m and current liabilities of AU$18m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On Acrow Formwork and Construction Services's ROCE
With that in mind, we're not overly impressed with Acrow Formwork and Construction Services's ROCE, so it may not be the most appealing prospect. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.