Today we'll look at Spindex Industries Limited (SGX:564) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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. 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?
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 Spindex Industries:
0.13 = S$15m ÷ (S$153m - S$36m) (Based on the trailing twelve months to March 2019.)
Therefore, Spindex Industries has an ROCE of 13%.
Does Spindex Industries Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Spindex Industries's ROCE appears to be substantially greater than the 10% average in the Machinery 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. Independently of how Spindex Industries compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Spindex Industries currently has an ROCE of 13%, less than the 18% it reported 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Spindex Industries's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Spindex Industries has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Spindex Industries'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Spindex Industries has total assets of S$153m and current liabilities of S$36m. As a result, its current liabilities are equal to approximately 24% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Spindex Industries's ROCE
With that in mind, Spindex Industries's ROCE appears pretty good. Spindex Industries looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.