Today we are going to look at Decmil Group Limited (ASX:DCG) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.
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 Decmil Group:
0.012 = AU$2.6m ÷ (AU$304m – AU$96m) (Based on the trailing twelve months to June 2018.)
Therefore, Decmil Group has an ROCE of 1.2%.
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Does Decmil Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Decmil Group’s ROCE appears meaningfully below the 23% average reported by the Construction industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Decmil Group’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
As we can see, Decmil Group currently has an ROCE of 1.2%, less than the 18% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
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. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.