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Why You Should Like Midway Limited’s (ASX:MWY) ROCE

Simply Wall St

Today we'll evaluate Midway Limited (ASX:MWY) 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 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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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'.

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 Midway:

0.15 = AU$35m ÷ (AU$277m - AU$39m) (Based on the trailing twelve months to June 2019.)

Therefore, Midway has an ROCE of 15%.

See our latest analysis for Midway

Does Midway Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Midway's ROCE is meaningfully higher than the 10% average in the Forestry industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Midway's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Midway's current ROCE of 15% is lower than 3 years ago, when the company reported a 21% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Midway's past growth compares to other companies.

ASX:MWY Past Revenue and Net Income, August 28th 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Midway's 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.

Midway has total liabilities of AU$39m and total assets of AU$277m. As a result, its current liabilities are equal to approximately 14% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

What We Can Learn From Midway's ROCE

With that in mind, Midway's ROCE appears pretty good. Midway 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.

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.