Today we are going to look at Xebec Adsorption Inc. (CVE:XBC) to see whether it might be an attractive investment prospect. 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.
Firstly, 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 Xebec Adsorption:
0.13 = CA$1.5m ÷ (CA$22m - CA$10m) (Based on the trailing twelve months to June 2019.)
So, Xebec Adsorption has an ROCE of 13%.
Is Xebec Adsorption's ROCE Good?
One way to assess ROCE is to compare similar companies. Xebec Adsorption's ROCE appears to be substantially greater than the 9.3% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Xebec Adsorption's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Xebec Adsorption's ROCE compares to its industry. Click to see more on past growth.
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, after all, simply a snap shot of a single year. 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 Xebec Adsorption's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Xebec Adsorption has total assets of CA$22m and current liabilities of CA$10m. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Xebec Adsorption has a medium level of current liabilities, which would boost the ROCE.
What We Can Learn From Xebec Adsorption's ROCE
Xebec Adsorption's ROCE does look good, but the level of current liabilities also contribute to that. Xebec Adsorption looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.