Why You Should Care About Second Chance Properties Ltd’s (SGX:528) Low Return On Capital
Today we'll look at Second Chance Properties Ltd (SGX:528) 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.
Firstly, we'll go over how we 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.
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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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'.
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 Second Chance Properties:
0.038 = S$10m ÷ (S$286m - S$20m) (Based on the trailing twelve months to February 2020.)
Therefore, Second Chance Properties has an ROCE of 3.8%.
Check out our latest analysis for Second Chance Properties
Does Second Chance Properties Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In this analysis, Second Chance Properties's ROCE appears meaningfully below the 12% average reported by the Specialty Retail industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Second Chance Properties stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
You can see in the image below how Second Chance Properties'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Second Chance Properties has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Second Chance Properties's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Second Chance Properties has current liabilities of S$20m and total assets of S$286m. Therefore its current liabilities are equivalent to approximately 7.1% of its total assets. Second Chance Properties has a low level of current liabilities, which have a negligible impact on its already low ROCE.
The Bottom Line On Second Chance Properties's ROCE
Nevertheless, there are potentially more attractive companies to invest in. You might be able to find a better investment than Second Chance Properties. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
Second Chance Properties is not the only stock insiders are buying. So take a peek at this free list of growing companies with insider buying.
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.
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. Thank you for reading.
