Today we'll evaluate Allegheny Technologies Incorporated (NYSE:ATI) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
So, How Do We Calculate ROCE?
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 Allegheny Technologies:
0.06 = US$289m ÷ (US$5.5b - US$759m) (Based on the trailing twelve months to June 2019.)
Therefore, Allegheny Technologies has an ROCE of 6.0%.
Does Allegheny Technologies Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Allegheny Technologies's ROCE appears to be significantly below the 9.0% average in the Metals and Mining industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Allegheny Technologies's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Allegheny Technologies delivered an ROCE of 6.0%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how Allegheny Technologies's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Given the industry it operates in, Allegheny Technologies could be considered cyclical. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Allegheny Technologies.
Do Allegheny Technologies's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Allegheny Technologies has total liabilities of US$759m and total assets of US$5.5b. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Allegheny Technologies's ROCE
With that in mind, we're not overly impressed with Allegheny Technologies's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than Allegheny Technologies. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
Allegheny Technologies is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.