Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we'll evaluate Badger Daylighting Ltd. (TSE:BAD) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to 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.
Understanding 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. Overall, it is a valuable metric that has its flaws. 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 Badger Daylighting:
0.21 = CA$100m ÷ (CA$603m - CA$131m) (Based on the trailing twelve months to March 2019.)
So, Badger Daylighting has an ROCE of 21%.
Is Badger Daylighting's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Badger Daylighting's ROCE appears to be substantially greater than the 7.8% average in the Construction industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Badger Daylighting's ROCE in absolute terms currently looks quite high.
In our analysis, Badger Daylighting's ROCE appears to be 21%, compared to 3 years ago, when its ROCE was 14%. This makes us think the business might be improving. The image below shows how Badger Daylighting's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Badger Daylighting.
Badger Daylighting's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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.
Badger Daylighting has total liabilities of CA$131m and total assets of CA$603m. Therefore its current liabilities are equivalent to approximately 22% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Badger Daylighting's ROCE
Low current liabilities and high ROCE is a good combination, making Badger Daylighting look quite interesting. Badger Daylighting looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Badger Daylighting better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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.