Today we'll look at UMS Holdings Limited (SGX:558) 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.
First up, we'll look at what ROCE is and how we calculate it. 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 is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 UMS Holdings:
0.13 = S$32m ÷ (S$281m - S$30m) (Based on the trailing twelve months to September 2019.)
Therefore, UMS Holdings has an ROCE of 13%.
Is UMS Holdings's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that UMS Holdings's ROCE is fairly close to the Semiconductor industry average of 12%. Independently of how UMS Holdings compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how UMS Holdings'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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for UMS Holdings.
How UMS Holdings's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
UMS Holdings has total liabilities of S$30m and total assets of S$281m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From UMS Holdings's ROCE
This is good to see, and with a sound ROCE, UMS Holdings could be worth a closer look. There might be better investments than UMS Holdings out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like UMS Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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