In This Article:
Today we'll evaluate Emeco Holdings Limited (ASX:EHL) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
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?
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 Emeco Holdings:
0.16 = AU$103m ÷ (AU$769m - AU$106m) (Based on the trailing twelve months to June 2019.)
So, Emeco Holdings has an ROCE of 16%.
Check out our latest analysis for Emeco Holdings
Is Emeco Holdings's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Emeco Holdings's ROCE appears to be substantially greater than the 8.8% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Emeco Holdings's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Emeco Holdings has an ROCE of 16%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. You can see in the image below how Emeco Holdings'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Emeco Holdings's Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.