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Today we are going to look at AusGroup Limited (SGX:5GJ) 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 AusGroup:

0.14 = AU$25m ÷ (AU$237m - AU$64m) (Based on the trailing twelve months to March 2019.)

Therefore, AusGroup has an ROCE of 14%.

View our latest analysis for AusGroup

Is AusGroup's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. AusGroup's ROCE appears to be substantially greater than the 4.3% average in the Construction industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how AusGroup compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

AusGroup has an ROCE of 14%, but it didn't have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving. The image below shows how AusGroup'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. 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. If AusGroup is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect AusGroup'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. 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.