In This Article:
Today we’ll evaluate VEEM Ltd (ASX:VEE) 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. 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 amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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?
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 VEEM:
0.095 = AU$3.7m ÷ (AU$52m – AU$13m) (Based on the trailing twelve months to June 2018.)
Therefore, VEEM has an ROCE of 9.5%.
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Does VEEM Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, VEEM’s ROCE appears to be around the 8.5% average of the Machinery industry. Aside from the industry comparison, VEEM’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
As we can see, VEEM currently has an ROCE of 9.5%, 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. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. How cyclical is VEEM? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
VEEM’s Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.