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Should You Like PWR Holdings Limited’s (ASX:PWH) High Return On Capital Employed?

Simply Wall St

Today we'll evaluate PWR Holdings Limited (ASX:PWH) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 PWR Holdings:

0.35 = AU$21m ÷ (AU$67m - AU$8.2m) (Based on the trailing twelve months to December 2019.)

So, PWR Holdings has an ROCE of 35%.

Check out our latest analysis for PWR Holdings

Is PWR Holdings's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. PWR Holdings's ROCE appears to be substantially greater than the 7.5% average in the Auto Components industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, PWR Holdings's ROCE in absolute terms currently looks quite high.

You can click on the image below to see (in greater detail) how PWR Holdings's past growth compares to other companies.

ASX:PWH Past Revenue and Net Income May 14th 2020
ASX:PWH Past Revenue and Net Income May 14th 2020

It is important to remember that ROCE shows past performance, and is 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for PWR Holdings.

How PWR Holdings's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

PWR Holdings has current liabilities of AU$8.2m and total assets of AU$67m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

The Bottom Line On PWR Holdings's ROCE

, There might be better investments than PWR Holdings 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.

There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.