In This Article:
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Today we'll look at AusGroup Limited (SGX:5GJ) 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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.'
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 AusGroup:
0.14 = AU$25m ÷ (AU$237m - AU$64m) (Based on the trailing twelve months to March 2019.)
Therefore, AusGroup has an ROCE of 14%.
Check out our latest analysis for AusGroup
Is AusGroup's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, AusGroup's ROCE is meaningfully higher than the 4.3% average in the Construction industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how AusGroup compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
AusGroup has an ROCE of 14%, but it didn't have an ROCE 3 years ago, since it was unprofitable. This makes us wonder if the company is improving. You can see in the image below how AusGroup'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. 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, after all, simply a snap shot of a single year. You can check if AusGroup has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.