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Is Australian Vintage Ltd (ASX:AVG) Struggling With Its 4.5% Return On Capital Employed?

Today we'll evaluate Australian Vintage Ltd (ASX:AVG) 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Australian Vintage:

0.045 = AU$19m ÷ (AU$478m - AU$46m) (Based on the trailing twelve months to December 2019.)

Therefore, Australian Vintage has an ROCE of 4.5%.

See our latest analysis for Australian Vintage

Is Australian Vintage's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Australian Vintage's ROCE appears meaningfully below the 8.0% average reported by the Beverage industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Australian Vintage's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

We can see that, Australian Vintage currently has an ROCE of 4.5% compared to its ROCE 3 years ago, which was 3.0%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Australian Vintage's ROCE compares to its industry. Click to see more on past growth.

ASX:AVG Past Revenue and Net Income April 9th 2020
ASX:AVG Past Revenue and Net Income April 9th 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Australian Vintage.

Australian Vintage'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 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.

Australian Vintage has total assets of AU$478m and current liabilities of AU$46m. As a result, its current liabilities are equal to approximately 9.5% of its total assets. With low levels of current liabilities, at least Australian Vintage's mediocre ROCE is not unduly boosted.

Our Take On Australian Vintage's ROCE

If performance improves, then Australian Vintage may be an OK investment, especially at the right valuation. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.