Why We’re Not Keen On World Precision Machinery Limited’s (SGX:B49) 0.4% Return On Capital
Today we’ll evaluate World Precision Machinery Limited (SGX:B49) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 World Precision Machinery:
0.004 = CN¥24m ÷ (CN¥1.6b – CN¥475m) (Based on the trailing twelve months to September 2018.)
Therefore, World Precision Machinery has an ROCE of 0.4%.
View our latest analysis for World Precision Machinery
Does World Precision Machinery Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, World Precision Machinery’s ROCE appears meaningfully below the 8.5% average reported by the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside World Precision Machinery’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
World Precision Machinery’s current ROCE of 0.4% is lower than 3 years ago, when the company reported a 7.5% ROCE. Therefore we wonder if the company is facing new headwinds.
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 World Precision Machinery is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
World Precision Machinery’s Current Liabilities And Their Impact On 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
World Precision Machinery has total liabilities of CN¥475m and total assets of CN¥1.6b. As a result, its current liabilities are equal to approximately 30% of its total assets. World Precision Machinery has a medium level of current liabilities (boosting the ROCE somewhat), and a low ROCE.
Our Take On World Precision Machinery’s ROCE
This company may not be the most attractive investment prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like World Precision Machinery 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.
