Today we'll evaluate AB Builders Group Limited (HKG:1615) 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. And finally, we'll look at how its current liabilities are impacting 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. 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 AB Builders Group:
0.15 = MO$37m ÷ (MO$377m - MO$126m) (Based on the trailing twelve months to June 2019.)
Therefore, AB Builders Group has an ROCE of 15%.
Does AB Builders Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. AB Builders Group's ROCE appears to be substantially greater than the 12% average in the Construction 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 AB Builders Group's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how AB Builders Group's past growth compares to other companies.
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, after all, simply a snap shot of a single year. How cyclical is AB Builders Group? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect AB Builders Group'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.
AB Builders Group has total assets of MO$377m and current liabilities of MO$126m. Therefore its current liabilities are equivalent to approximately 34% of its total assets. With this level of current liabilities, AB Builders Group's ROCE is boosted somewhat.
What We Can Learn From AB Builders Group's ROCE
AB Builders Group's ROCE does look good, but the level of current liabilities also contribute to that. AB Builders Group 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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