Today we'll look at American Vanguard Corporation (NYSE:AVD) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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?
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 American Vanguard:
0.058 = US$31m ÷ (US$681m - US$143m) (Based on the trailing twelve months to September 2019.)
So, American Vanguard has an ROCE of 5.8%.
Does American Vanguard Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, American Vanguard's ROCE appears to be significantly below the 9.9% average in the Chemicals industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how American Vanguard stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how American Vanguard'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for American Vanguard.
How American Vanguard's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
American Vanguard has current liabilities of US$143m and total assets of US$681m. As a result, its current liabilities are equal to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From American Vanguard's ROCE
With that in mind, we're not overly impressed with American Vanguard's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than American Vanguard. 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).
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 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.
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