Today we are going to look at North American Construction Group Ltd. (TSE:NOA) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?
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 North American Construction Group:
0.058 = CA$32m ÷ (CA$690m – CA$149m) (Based on the trailing twelve months to December 2018.)
So, North American Construction Group has an ROCE of 5.8%.
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Does North American Construction Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that North American Construction Group’s ROCE is fairly close to the Energy Services industry average of 6.8%. Separate from how North American Construction Group stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
In our analysis, North American Construction Group’s ROCE appears to be 5.8%, compared to 3 years ago, when its ROCE was 1.7%. 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. 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 North American Construction Group are cyclical businesses. Since the future is so important for investors, you should check out our free report on analyst forecasts for North American Construction Group.
What Are Current Liabilities, And How Do They Affect North American Construction Group’s 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.
North American Construction Group has total liabilities of CA$149m and total assets of CA$690m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
The Bottom Line On North American Construction Group’s ROCE
That said, North American Construction Group’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than North American Construction Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like North American Construction Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Thank you for reading.