In This Article:
Today we’ll evaluate SBS Transit Ltd (SGX:S61) 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.
First, 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.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 SBS Transit:
0.12 = S$59m ÷ (S$1.1b – S$402m) (Based on the trailing twelve months to September 2018.)
Therefore, SBS Transit has an ROCE of 12%.
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Is SBS Transit’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that SBS Transit’s ROCE is fairly close to the Transportation industry average of 11%. Independently of how SBS Transit compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that SBS Transit currently has an ROCE of 12%, compared to its ROCE of 3.3% 3 years ago. This makes us think the business might be improving.
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. How cyclical is SBS Transit? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How SBS Transit’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 counter this, investors can check if a company has high current liabilities relative to total assets.