Today we'll look at Amiad Water Systems Ltd. (LON:AFS) and reflect on its potential as an investment. 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. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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?
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 Amiad Water Systems:
0.061 = US$5.5m ÷ (US$139m - US$49m) (Based on the trailing twelve months to June 2019.)
Therefore, Amiad Water Systems has an ROCE of 6.1%.
See our latest analysis for Amiad Water Systems
Is Amiad Water Systems's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Amiad Water Systems's ROCE appears meaningfully below the 13% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Amiad Water Systems's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Amiad Water Systems's current ROCE of 6.1% is lower than 3 years ago, when the company reported a 9.0% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Amiad Water Systems's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Amiad Water Systems.