Design Studio Group Ltd’s Stock Is Trading Near A 52-Week Low: Does The Company Have A Quality Busines?

Design Studio Group Ltd (SGX: D11) is a company that provides high-end interior fit-out and joinery solutions. It has two main business segments, namely, Residential property, and Hospitality and commercial.

At the current price of S$0.555, Design Studio’s stock is just 7.8% higher than a 52-week low of S$0.515. This captured my attention and got me interested in finding out more about the company. In particular, I want to understand: Does it have a high quality business?

This question is important. If Design Studio has a high quality business, its current low stock price could be an investment opportunity. Unfortunately, there’s no easy answer to the question. But, a simple metric can help shed some light on the question: The return on invested capital (ROIC).

A brief introduction to the ROIC

In a previous article of mine, I explained how the ROIC can be used to evaluate the quality of a business.

The simple idea behind the ROIC is that a business with a higher ROIC requires less capital to generate a profit, and it thus gives investors a higher return per dollar that is invested in the business. High-quality businesses tend to have high ROICs while the reverse is true – a low ROIC is often associated with a low-quality business.

You can see how the math works for the ROIC in the formula above.

Design Studio’s ROIC

Here’s a table showing how Design Studio’s ROIC looks like (I had used numbers from its fiscal year ended 31 December 2016):

Source: Design Studio annual report

In 2016, Design Studio generated a ROIC of 48.4%. This means that for every dollar of capital invested in the business, Design Studio earned 48.4 cents in profit. The company’s ROIC of 48.4% is way above average, based on the ROICs of many other companies I have studied in the past. This suggests that Design Studio’s business quality is ranked among the best.

As investors, we also need to understand just how a company manages to generate a high ROIC. Fortunately, it’s not too difficult to understand this with Design Studio.

Firstly, though Design Studio has a significant amount of investment in factory buildings and machinery (S$53.50 million at end-2016), most of the investments have undergone depreciation over the years (total accumulated depreciation at end-2016 was S$38.45 million), leaving a relatively small value.

Secondly, the largest working capital requirement for the company is account receivables, which stood at S$72.94 million at the end of 2016. These receivables were mostly funded by its trade payables of S$68.82 million.

Both factors, when put together, allow Design Studio to generate a high ROIC.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Lawrence Nga doesn’t own shares in any companies mentioned.