Today we'll evaluate Sapphire Corporation Limited (SGX:BRD) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. 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 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.
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 Sapphire:
0.073 = CN¥43m ÷ (CN¥2.3b - CN¥1.7b) (Based on the trailing twelve months to June 2019.)
Therefore, Sapphire has an ROCE of 7.3%.
Is Sapphire's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Sapphire's ROCE is meaningfully higher than the 4.4% average in the Construction industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from how Sapphire stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Sapphire's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. How cyclical is Sapphire? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Sapphire'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Sapphire has total liabilities of CN¥1.7b and total assets of CN¥2.3b. Therefore its current liabilities are equivalent to approximately 74% of its total assets. With a high level of current liabilities, Sapphire will experience a boost to its ROCE.
The Bottom Line On Sapphire's ROCE
Even so, the company reports a mediocre ROCE, and there may be better investments out there. You might be able to find a better investment than Sapphire. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 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.