Today we'll evaluate Domain Holdings Australia Limited (ASX:DHG) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Domain Holdings Australia:
0.036 = AU$52m ÷ (AU$1.5b - AU$55m) (Based on the trailing twelve months to December 2019.)
So, Domain Holdings Australia has an ROCE of 3.6%.
Is Domain Holdings Australia's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Domain Holdings Australia's ROCE is meaningfully below the Interactive Media and Services industry average of 15%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Domain Holdings Australia compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.1% available in government bonds. It is likely that there are more attractive prospects out there.
You can click on the image below to see (in greater detail) how Domain Holdings Australia's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Domain Holdings Australia's Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Domain Holdings Australia has current liabilities of AU$55m and total assets of AU$1.5b. As a result, its current liabilities are equal to approximately 3.6% of its total assets. Domain Holdings Australia has very few current liabilities, which have a minimal effect on its already low ROCE.
Our Take On Domain Holdings Australia's ROCE
Still, investors could probably find more attractive prospects with better performance out there. Of course, you might also be able to find a better stock than Domain Holdings Australia. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.
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