Today we'll look at Asahi Songwon Colors Limited (NSE:ASAHISONG) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Asahi Songwon Colors:
0.12 = ₹277m ÷ (₹3.1b - ₹770m) (Based on the trailing twelve months to June 2019.)
So, Asahi Songwon Colors has an ROCE of 12%.
Is Asahi Songwon Colors's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Asahi Songwon Colors's ROCE appears meaningfully below the 17% average reported by the Chemicals industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Asahi Songwon Colors'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.
We can see that , Asahi Songwon Colors currently has an ROCE of 12%, less than the 22% it reported 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 Asahi Songwon Colors'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. ROCE is only a point-in-time measure. If Asahi Songwon Colors is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Asahi Songwon Colors's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Asahi Songwon Colors has total assets of ₹3.1b and current liabilities of ₹770m. As a result, its current liabilities are equal to approximately 25% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Asahi Songwon Colors's ROCE
That said, Asahi Songwon Colors's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Asahi Songwon Colors. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Asahi Songwon Colors better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.