Is Samuel Heath & Sons PLC's (LON:HSM) Capital Allocation Ability Worth Your Time?
Today we'll look at Samuel Heath & Sons PLC (LON:HSM) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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'.
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 Samuel Heath & Sons:
0.12 = UK£1.4m ÷ (UK£14m - UK£2.0m) (Based on the trailing twelve months to March 2019.)
Therefore, Samuel Heath & Sons has an ROCE of 12%.
View our latest analysis for Samuel Heath & Sons
Is Samuel Heath & Sons's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Samuel Heath & Sons's ROCE is around the 12% average reported by the Building industry. Independently of how Samuel Heath & Sons compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
The image below shows how Samuel Heath & Sons's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Samuel Heath & Sons? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Samuel Heath & Sons's Current Liabilities Skew 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 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Samuel Heath & Sons has total assets of UK£14m and current liabilities of UK£2.0m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Samuel Heath & Sons's ROCE
Overall, Samuel Heath & Sons has a decent ROCE and could be worthy of further research. There might be better investments than Samuel Heath & Sons 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.
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.
