Today we'll evaluate HiTech Group Australia Limited (ASX:HIT) 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 up, we'll look at what ROCE is and how we calculate it. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 HiTech Group Australia:
0.52 = AU$3.8m ÷ (AU$9.9m - AU$2.6m) (Based on the trailing twelve months to June 2019.)
So, HiTech Group Australia has an ROCE of 52%.
Does HiTech Group Australia Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, HiTech Group Australia's ROCE is meaningfully higher than the 18% average in the Professional Services 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. Putting aside its position relative to its industry for now, in absolute terms, HiTech Group Australia's ROCE is currently very good.
The image below shows how HiTech Group Australia's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is only a point-in-time measure. If HiTech Group Australia is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How HiTech Group Australia's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.
HiTech Group Australia has total liabilities of AU$2.6m and total assets of AU$9.9m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.
Our Take On HiTech Group Australia's ROCE
With low current liabilities and a high ROCE, HiTech Group Australia could be worthy of further investigation. There might be better investments than HiTech Group Australia out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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If you spot an error that warrants correction, please contact the editor at email@example.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.