U.S. Markets open in 4 hrs 2 mins

Here’s why QMS Media Limited’s (ASX:QMS) Returns On Capital Matters So Much

Simply Wall St

Today we'll evaluate QMS Media Limited (ASX:QMS) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

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. 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 QMS Media:

0.06 = AU$25m ÷ (AU$464m - AU$54m) (Based on the trailing twelve months to December 2018.)

Therefore, QMS Media has an ROCE of 6.0%.

Check out our latest analysis for QMS Media

Is QMS Media's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, QMS Media's ROCE appears to be significantly below the 8.6% average in the Media industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, QMS Media's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

The image below shows how QMS Media's ROCE compares to its industry, and you can click it to see more detail on its past growth.

ASX:QMS Past Revenue and Net Income, August 16th 2019

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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for QMS Media.

QMS Media's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

QMS Media has total liabilities of AU$54m and total assets of AU$464m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

The Bottom Line On QMS Media's ROCE

That said, QMS Media's ROCE is mediocre, there may be more attractive investments around. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like QMS Media better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.