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Why Amiad Water Systems Ltd.’s (LON:AFS) Return On Capital Employed Looks Uninspiring

Declan Brown

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Today we’ll evaluate Amiad Water Systems Ltd. (LON:AFS) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

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 Amiad Water Systems:

0.071 = US$5.1m ÷ (US$113m – US$37m) (Based on the trailing twelve months to June 2018.)

So, Amiad Water Systems has an ROCE of 7.1%.

View our latest analysis for Amiad Water Systems

Does Amiad Water Systems Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Amiad Water Systems’s ROCE is meaningfully below the Machinery industry average of 13%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Amiad Water Systems stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

AIM:AFS Last Perf February 15th 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Amiad Water Systems.

Amiad Water Systems’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Amiad Water Systems has total assets of US$113m and current liabilities of US$37m. As a result, its current liabilities are equal to approximately 33% of its total assets. Amiad Water Systems’s ROCE is improved somewhat by its moderate amount of current liabilities.

The Bottom Line On Amiad Water Systems’s ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. But note: Amiad Water Systems may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Amiad Water Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.