Today we'll look at 1300SMILES Limited (ASX:ONT) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Ultimately, it is a useful but imperfect metric. 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 1300SMILES:
0.19 = AU$9.8m ÷ (AU$57m - AU$5.1m) (Based on the trailing twelve months to June 2019.)
So, 1300SMILES has an ROCE of 19%.
Does 1300SMILES Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, we find that 1300SMILES's ROCE is meaningfully better than the 10.0% average in the Healthcare 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. Separate from 1300SMILES's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
1300SMILES's current ROCE of 19% is lower than its ROCE in the past, which was 30%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how 1300SMILES's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and 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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for 1300SMILES.
How 1300SMILES's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
1300SMILES has total assets of AU$57m and current liabilities of AU$5.1m. Therefore its current liabilities are equivalent to approximately 8.8% of its total assets. With low current liabilities, 1300SMILES's decent ROCE looks that much more respectable.
What We Can Learn From 1300SMILES's ROCE
This is good to see, and while better prospects may exist, 1300SMILES seems worth researching further. 1300SMILES 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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.