Today we'll evaluate Hammond Manufacturing Company Limited (TSE:HMM.A) 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. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. 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 Hammond Manufacturing:
0.11 = CA$7.8m ÷ (CA$111m - CA$42m) (Based on the trailing twelve months to September 2019.)
So, Hammond Manufacturing has an ROCE of 11%.
See our latest analysis for Hammond Manufacturing
Does Hammond Manufacturing Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Hammond Manufacturing's ROCE appears to be around the 10% average of the Electrical industry. Separate from Hammond Manufacturing's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that, Hammond Manufacturing currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 6.7%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Hammond Manufacturing'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. ROCE is only a point-in-time measure. If Hammond Manufacturing is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Hammond Manufacturing'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.
Hammond Manufacturing has total assets of CA$111m and current liabilities of CA$42m. Therefore its current liabilities are equivalent to approximately 38% of its total assets. Hammond Manufacturing has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Hammond Manufacturing's ROCE
Hammond Manufacturing's ROCE does look good, but the level of current liabilities also contribute to that. Hammond Manufacturing 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.
There are plenty of other companies that have insiders buying up shares. You probably do not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
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. Thank you for reading.
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