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Today we'll evaluate Nera Telecommunications Ltd (SGX:N01) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Nera Telecommunications:
0.16 = S$11m ÷ (S$174m - S$101m) (Based on the trailing twelve months to March 2019.)
Therefore, Nera Telecommunications has an ROCE of 16%.
Is Nera Telecommunications's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Nera Telecommunications's ROCE is meaningfully higher than the 12% average in the Communications industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Nera Telecommunications compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. ROCE is, after all, simply a snap shot of a single year. If Nera Telecommunications is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Nera Telecommunications's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Nera Telecommunications has total liabilities of S$101m and total assets of S$174m. As a result, its current liabilities are equal to approximately 58% of its total assets. Nera Telecommunications has a relatively high level of current liabilities, boosting its ROCE meaningfully.
What We Can Learn From Nera Telecommunications's ROCE
While its ROCE looks decent, it wouldn't look so good if it reduced current liabilities. There might be better investments than Nera Telecommunications out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Nera Telecommunications better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 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.