In This Article:
Today we'll look at Mitchell Services Limited (ASX:MSV) 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Mitchell Services:
0.31 = AU$14m ÷ (AU$70m - AU$26m) (Based on the trailing twelve months to June 2019.)
So, Mitchell Services has an ROCE of 31%.
Check out our latest analysis for Mitchell Services
Is Mitchell Services's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Mitchell Services's ROCE appears to be substantially greater than the 8.0% average in the Metals and Mining 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. Putting aside its position relative to its industry for now, in absolute terms, Mitchell Services's ROCE is currently very good.
Mitchell Services delivered an ROCE of 31%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can see in the image below how Mitchell Services'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 only a point-in-time measure. We note Mitchell Services could be considered a cyclical business. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Mitchell Services.