SDI Limited (ASX:SDI) Earns A Nice Return On Capital Employed
Today we'll look at SDI Limited (ASX:SDI) 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.
Firstly, we'll go over how we calculate ROCE. 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. 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 SDI:
0.14 = AU$11m ÷ (AU$90m - AU$12m) (Based on the trailing twelve months to December 2019.)
So, SDI has an ROCE of 14%.
View our latest analysis for SDI
Does SDI Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, SDI's ROCE is meaningfully higher than the 11% average in the Medical Equipment industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from SDI's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how SDI's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is SDI? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect SDI's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
SDI has total assets of AU$90m and current liabilities of AU$12m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On SDI's ROCE
With that in mind, SDI's ROCE appears pretty good. SDI 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.
SDI is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
