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Today we’ll look at ISDN Holdings Limited (SGX:I07) 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.
First, we’ll go over how we calculate ROCE. 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?
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 ISDN Holdings:
0.16 = S$21m ÷ (S$257m – S$84m) (Based on the trailing twelve months to September 2018.)
So, ISDN Holdings has an ROCE of 16%.
See our latest analysis for ISDN Holdings
Is ISDN Holdings’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. ISDN Holdings’s ROCE appears to be substantially greater than the 13% average in the Electrical industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where ISDN Holdings sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, ISDN Holdings’s ROCE appears to be 16%, compared to 3 years ago, when its ROCE was 11%. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, 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 ISDN Holdings.
What Are Current Liabilities, And How Do They Affect ISDN Holdings’s 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 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.