Today we'll look at Sunningdale Tech Ltd (SGX:BHQ) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we 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.
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. 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.
How Do You Calculate Return On Capital Employed?
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 Sunningdale Tech:
0.03 = S$13m ÷ (S$709m - S$273m) (Based on the trailing twelve months to December 2019.)
Therefore, Sunningdale Tech has an ROCE of 3.0%.
Check out our latest analysis for Sunningdale Tech
Is Sunningdale Tech's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Sunningdale Tech's ROCE is meaningfully below the Machinery industry average of 6.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Sunningdale Tech stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Sunningdale Tech's current ROCE of 3.0% is lower than 3 years ago, when the company reported a 9.3% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Sunningdale Tech'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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Sunningdale Tech.
How Sunningdale Tech's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.