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Today we are going to look at Powermatic Data Systems Limited (SGX:BCY) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. 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. 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'.
How Do You Calculate Return On Capital Employed?
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 Powermatic Data Systems:
0.17 = S$11m ÷ (S$67m - S$5.9m) (Based on the trailing twelve months to September 2019.)
Therefore, Powermatic Data Systems has an ROCE of 17%.
Does Powermatic Data Systems Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Powermatic Data Systems's ROCE appears to be substantially greater than the 6.8% average in the Communications 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. Regardless of where Powermatic Data Systems sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Powermatic Data Systems currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 9.3%. This makes us think the business might be improving. You can see in the image below how Powermatic Data Systems'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. 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. If Powermatic Data Systems is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Powermatic Data Systems'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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Powermatic Data Systems has total assets of S$67m and current liabilities of S$5.9m. As a result, its current liabilities are equal to approximately 8.8% of its total assets. Low current liabilities have only a minimal impact on Powermatic Data Systems's ROCE, making its decent returns more credible.
Our Take On Powermatic Data Systems's ROCE
If it is able to keep this up, Powermatic Data Systems could be attractive. There might be better investments than Powermatic Data Systems 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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