Today we’ll look at Shawcor Ltd. (TSE:SCL) 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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.
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 Shawcor:
0.011 = CA$18m ÷ (CA$2.0b – CA$333m) (Based on the trailing twelve months to September 2019.)
Therefore, Shawcor has an ROCE of 1.1%.
View our latest analysis for Shawcor
Is Shawcor’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Shawcor’s ROCE appears to be significantly below the 7.6% average in the Energy Services 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 Shawcor compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.4% available in government bonds. There are potentially more appealing investments elsewhere.
The image below shows how Shawcor’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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, after all, simply a snap shot of a single year. Remember that most companies like Shawcor are cyclical businesses. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Shawcor’s Current Liabilities And Their Impact On Its 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 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.
Shawcor has current liabilities of CA$333m and total assets of CA$2.0b. As a result, its current liabilities are equal to approximately 17% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
What We Can Learn From Shawcor’s ROCE
Shawcor has a poor ROCE, and there may be better investment prospects out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at [email protected]. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
The easiest way to discover new investment ideas
Save hours of research when discovering your next investment with Simply Wall St. Looking for companies potentially undervalued based on their future cash flows? Or maybe you’re looking for sustainable dividend payers or high growth potential stocks. Customise your search to easily find new investment opportunities that match your investment goals. And the best thing about it? It’s FREE. Click here to learn more.
