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Why AEM Holdings Ltd’s (SGX:AWX) Return On Capital Employed Is Impressive

Simply Wall St

Today we'll look at AEM Holdings Ltd (SGX:AWX) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

What is 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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 AEM Holdings:

0.44 = S$48m ÷ (S$185m - S$75m) (Based on the trailing twelve months to June 2019.)

Therefore, AEM Holdings has an ROCE of 44%.

View our latest analysis for AEM Holdings

Does AEM Holdings Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that AEM Holdings's ROCE is meaningfully better than the 12% average in the Semiconductor 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. Regardless of the industry comparison, in absolute terms, AEM Holdings's ROCE currently appears to be excellent.

We can see that, AEM Holdings currently has an ROCE of 44% compared to its ROCE 3 years ago, which was 26%. This makes us wonder if the company is improving. You can see in the image below how AEM Holdings's ROCE compares to its industry. Click to see more on past growth.

SGX:AWX Past Revenue and Net Income, October 15th 2019

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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

AEM Holdings's Current Liabilities And Their Impact On 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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

AEM Holdings has total assets of S$185m and current liabilities of S$75m. Therefore its current liabilities are equivalent to approximately 40% of its total assets. AEM Holdings's ROCE is boosted somewhat by its middling amount of current liabilities.

Our Take On AEM Holdings's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. AEM Holdings shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like AEM 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.

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 editorial-team@simplywallst.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.