Today we'll look at Ricegrowers Limited (ASX:SGLLV) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. 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?
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 Ricegrowers:
0.11 = AU$63m ÷ (AU$830m - AU$269m) (Based on the trailing twelve months to April 2019.)
Therefore, Ricegrowers has an ROCE of 11%.
Is Ricegrowers's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. It appears that Ricegrowers's ROCE is fairly close to the Food industry average of 10%. Independently of how Ricegrowers compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Ricegrowers currently has an ROCE of 11%, less than the 19% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Ricegrowers's past growth compares to other companies.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Ricegrowers has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Ricegrowers's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Ricegrowers has total assets of AU$830m and current liabilities of AU$269m. As a result, its current liabilities are equal to approximately 32% of its total assets. With this level of current liabilities, Ricegrowers's ROCE is boosted somewhat.
Our Take On Ricegrowers's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Ricegrowers shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Ricegrowers better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.