Today we'll evaluate Savaria Corporation (TSE:SIS) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 Savaria:
0.083 = CA$29m ÷ (CA$417m - CA$69m) (Based on the trailing twelve months to March 2019.)
So, Savaria has an ROCE of 8.3%.
Is Savaria's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Savaria's ROCE appears to be around the 9.3% average of the Machinery industry. Separate from how Savaria stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
Savaria's current ROCE of 8.3% is lower than its ROCE in the past, which was 19%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Savaria's past growth compares to other companies.
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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Savaria.
How Savaria's Current Liabilities Impact 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.
Savaria has total assets of CA$417m and current liabilities of CA$69m. As a result, its current liabilities are equal to approximately 17% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On Savaria's ROCE
That said, Savaria's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Savaria. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.