Today we’ll look at Advanced Micro Devices, Inc. (NASDAQ:AMD) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Advanced Micro Devices:
0.20 = US$204m ÷ (US$4.3b – US$1.9b) (Based on the trailing twelve months to September 2018.)
Therefore, Advanced Micro Devices has an ROCE of 20%.
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Does Advanced Micro Devices Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Advanced Micro Devices’s ROCE appears to be substantially greater than the 14% average in the Semiconductor industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where Advanced Micro Devices sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Advanced Micro Devices delivered an ROCE of 20%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving.
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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Advanced Micro Devices.
How Advanced Micro Devices’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Advanced Micro Devices has total assets of US$4.3b and current liabilities of US$1.9b. As a result, its current liabilities are equal to approximately 43% of its total assets. With this level of current liabilities, Advanced Micro Devices’s ROCE is boosted somewhat.
What We Can Learn From Advanced Micro Devices’s ROCE
While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. Of course you might be able to find a better stock than Advanced Micro Devices. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.