Today we are going to look at Diana Shipping Inc. (NYSE:DSX) to see whether it might be an attractive investment prospect. 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, 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 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 Diana Shipping:
0.036 = US$40m ÷ (US$1.2b – US$80m) (Based on the trailing twelve months to December 2018.)
So, Diana Shipping has an ROCE of 3.6%.
Is Diana Shipping’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Diana Shipping’s ROCE is meaningfully below the Shipping industry average of 4.8%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Diana Shipping compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.
Diana Shipping reported an ROCE of 3.6% — better than 3 years ago, when the company didn’t make a profit. That implies the business has been improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Diana Shipping.
How Diana Shipping’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Diana Shipping has total assets of US$1.2b and current liabilities of US$80m. As a result, its current liabilities are equal to approximately 6.8% of its total assets. Diana Shipping has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On Diana Shipping’s ROCE
Nevertheless, there are potentially more attractive companies to invest in. Of course you might be able to find a better stock than Diana Shipping. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.