Today we are going to look at SeaLink Travel Group Limited (ASX:SLK) to see whether it might be an attractive investment prospect. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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.
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 SeaLink Travel Group:
0.12 = AU$31m ÷ (AU$301m - AU$34m) (Based on the trailing twelve months to June 2019.)
Therefore, SeaLink Travel Group has an ROCE of 12%.
Is SeaLink Travel Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see SeaLink Travel Group's ROCE is around the 12% average reported by the Hospitality industry. Independently of how SeaLink Travel Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
SeaLink Travel Group's current ROCE of 12% is lower than its ROCE in the past, which was 17%, 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how SeaLink Travel Group's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for SeaLink Travel Group.
What Are Current Liabilities, And How Do They Affect SeaLink Travel Group's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
SeaLink Travel Group has total assets of AU$301m and current liabilities of AU$34m. As a result, its current liabilities are equal to approximately 11% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On SeaLink Travel Group's ROCE
This is good to see, and with a sound ROCE, SeaLink Travel Group could be worth a closer look. There might be better investments than SeaLink Travel Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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