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Is Argan, Inc.’s (NYSE:AGX) 11% Return On Capital Employed Good News?

Simply Wall St

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Today we are going to look at Argan, Inc. (NYSE:AGX) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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 measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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?

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 Argan:

0.11 = US$42m ÷ (US$477m - US$82m) (Based on the trailing twelve months to January 2019.)

Therefore, Argan has an ROCE of 11%.

View our latest analysis for Argan

Does Argan Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Argan's ROCE is around the 9.5% average reported by the Construction industry. Aside from the industry comparison, Argan'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.

Argan's current ROCE of 11% is lower than 3 years ago, when the company reported a 34% ROCE. So investors might consider if it has had issues recently.

NYSE:AGX Past Revenue and Net Income, June 7th 2019

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Argan.

Argan's Current Liabilities And Their Impact On 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Argan has total liabilities of US$82m and total assets of US$477m. As a result, its current liabilities are equal to approximately 17% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Argan's ROCE

That said, Argan's ROCE is mediocre, there may be more attractive investments around. You might be able to find a better investment than Argan. 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).

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 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. Thank you for reading.