In This Article:
Today we’ll evaluate EnGro Corporation Limited (SGX:S44) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 EnGro:
0.037 = S$8.7m ÷ (S$257m – S$23m) (Based on the trailing twelve months to December 2018.)
So, EnGro has an ROCE of 3.7%.
See our latest analysis for EnGro
Is EnGro’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, EnGro’s ROCE appears to be significantly below the 10% average in the Basic Materials industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how EnGro compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.3% available in government bonds. It is likely that there are more attractive prospects out there.
EnGro reported an ROCE of 3.7% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is EnGro? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do EnGro’s Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.