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Are Saga Communications, Inc.’s Returns On Capital Worth Investigating?

Simply Wall St

Today we'll evaluate Saga Communications, Inc. (NASDAQ:SGA) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to 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 amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Saga Communications:

0.087 = US$20m ÷ (US$247m - US$18m) (Based on the trailing twelve months to June 2019.)

So, Saga Communications has an ROCE of 8.7%.

Check out our latest analysis for Saga Communications

Does Saga Communications Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Saga Communications's ROCE is fairly close to the Media industry average of 8.8%. Aside from the industry comparison, Saga Communications's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Saga Communications's current ROCE of 8.7% is lower than its ROCE in the past, which was 12%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Saga Communications's past growth compares to other companies.

NasdaqGM:SGA Past Revenue and Net Income, September 3rd 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. You can check if Saga Communications has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do Saga Communications's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Saga Communications has total liabilities of US$18m and total assets of US$247m. Therefore its current liabilities are equivalent to approximately 7.1% of its total assets. Saga Communications reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

What We Can Learn From Saga Communications's ROCE

If performance improves, then Saga Communications may be an OK investment, especially at the right valuation. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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 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. Thank you for reading.