Today we'll look at Schaffer Corporation Limited (ASX:SFC) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. 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 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. 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 Schaffer:
0.20 = AU$38m ÷ (AU$247m - AU$54m) (Based on the trailing twelve months to December 2019.)
So, Schaffer has an ROCE of 20%.
Is Schaffer's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Schaffer's ROCE appears to be substantially greater than the 7.5% average in the Auto Components industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Schaffer's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Schaffer's ROCE appears to be 20%, compared to 3 years ago, when its ROCE was 3.8%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Schaffer's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Schaffer.
What Are Current Liabilities, And How Do They Affect Schaffer's 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Schaffer has total assets of AU$247m and current liabilities of AU$54m. As a result, its current liabilities are equal to approximately 22% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Schaffer's ROCE
With that in mind, Schaffer's ROCE appears pretty good. Schaffer 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.
I will like Schaffer better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.