What Can We Make Of African Media Entertainment Limited’s (JSE:AME) High Return On Capital? – Simply Wall St News


Today we are going to look at African Media Entertainment Limited (JSE:AME) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE 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. 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 African Media Entertainment:

0.23 = SAR56m ÷ (SAR291m – SAR48m) (Based on the trailing twelve months to September 2019.)

Therefore, African Media Entertainment has an ROCE of 23%.

Check out our latest analysis for African Media Entertainment

Does African Media Entertainment Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In our analysis, African Media Entertainment’s ROCE is meaningfully higher than the 9.5% average in the Media industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from African Media Entertainment’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

African Media Entertainment’s current ROCE of 23% is lower than its ROCE in the past, which was 32%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how African Media Entertainment’s ROCE compares to its industry. Click to see more on past growth.

JSE:AME Past Revenue and Net Income May 3rd 2020
JSE:AME Past Revenue and Net Income May 3rd 2020

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 African Media Entertainment is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do African Media Entertainment’s Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.

African Media Entertainment has current liabilities of SAR48m and total assets of SAR291m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On African Media Entertainment’s ROCE

Overall, African Media Entertainment has a decent ROCE and could be worthy of further research. There might be better investments than African Media Entertainment out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

If you are like me, then you will 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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