Today we'll evaluate Cleanaway Waste Management Limited (ASX:CWY) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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'.
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 Cleanaway Waste Management:
0.057 = AU$211m ÷ (AU$4.2b - AU$478m) (Based on the trailing twelve months to June 2019.)
So, Cleanaway Waste Management has an ROCE of 5.7%.
Is Cleanaway Waste Management's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Cleanaway Waste Management's ROCE is meaningfully below the Commercial Services industry average of 16%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Cleanaway Waste Management stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Our data shows that Cleanaway Waste Management currently has an ROCE of 5.7%, compared to its ROCE of 3.7% 3 years ago. This makes us think the business might be improving. You can see in the image below how Cleanaway Waste Management's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cleanaway Waste Management.
What Are Current Liabilities, And How Do They Affect Cleanaway Waste Management's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Cleanaway Waste Management has total liabilities of AU$478m and total assets of AU$4.2b. As a result, its current liabilities are equal to approximately 11% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Cleanaway Waste Management's ROCE
If Cleanaway Waste Management continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Cleanaway Waste Management. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 firstname.lastname@example.org. 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.