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Today we'll evaluate Golden Agri-Resources Ltd (SGX:E5H) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Golden Agri-Resources:
0.021 = US$125m ÷ (US$8.6b - US$2.7b) (Based on the trailing twelve months to March 2019.)
So, Golden Agri-Resources has an ROCE of 2.1%.
Is Golden Agri-Resources's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Golden Agri-Resources's ROCE appears to be significantly below the 6.7% average in the Food industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Golden Agri-Resources compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.3% available in government bonds. It is likely that there are more attractive prospects out there.
You can click on the image below to see (in greater detail) how Golden Agri-Resources's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Golden Agri-Resources.
What Are Current Liabilities, And How Do They Affect Golden Agri-Resources'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Golden Agri-Resources has total liabilities of US$2.7b and total assets of US$8.6b. As a result, its current liabilities are equal to approximately 32% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Golden Agri-Resources's ROCE is concerning.
Our Take On Golden Agri-Resources's ROCE
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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 firstname.lastname@example.org. 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.