Today we'll evaluate Pentamaster International Limited (HKG:1665) 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. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 Pentamaster International:
0.30 = RM106m ÷ (RM518m - RM168m) (Based on the trailing twelve months to March 2019.)
Therefore, Pentamaster International has an ROCE of 30%.
Is Pentamaster International's ROCE Good?
One way to assess ROCE is to compare similar companies. Pentamaster International's ROCE appears to be substantially greater than the 5.8% average in the Semiconductor industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Pentamaster International's ROCE in absolute terms currently looks quite high.
We can see that , Pentamaster International currently has an ROCE of 30% compared to its ROCE 3 years ago, which was 23%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Pentamaster International's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Pentamaster International's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Pentamaster International has total assets of RM518m and current liabilities of RM168m. As a result, its current liabilities are equal to approximately 32% of its total assets. Pentamaster International's ROCE is boosted somewhat by its middling amount of current liabilities.
The Bottom Line On Pentamaster International's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Pentamaster International 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.