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Today we'll look at Wajax Corporation (TSE:WJX) 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 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. Generally speaking a higher ROCE is better. 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?
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 Wajax:
0.12 = CA$63m ÷ (CA$831m - CA$290m) (Based on the trailing twelve months to December 2018.)
Therefore, Wajax has an ROCE of 12%.
Is Wajax's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Wajax's ROCE is meaningfully below the Trade Distributors industry average of 16%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Wajax compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Wajax's 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Wajax has total assets of CA$831m and current liabilities of CA$290m. Therefore its current liabilities are equivalent to approximately 35% of its total assets. Wajax has a medium level of current liabilities, which would boost the ROCE.
Our Take On Wajax's ROCE
Wajax's ROCE does look good, but the level of current liabilities also contribute to that. Of course you might be able to find a better stock than Wajax. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.