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Today we'll evaluate Badger Meter, Inc. (NYSE:BMI) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Badger Meter:
0.12 = US$41m ÷ (US$403m - US$58m) (Based on the trailing twelve months to March 2019.)
Therefore, Badger Meter has an ROCE of 12%.
Is Badger Meter's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Badger Meter's ROCE appears to be around the 12% average of the Electronic industry. Separate from Badger Meter's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Badger Meter's current ROCE of 12% is lower than its ROCE in the past, which was 19%, 3 years ago. So investors might consider if it has had issues recently.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Badger Meter.
How Badger Meter's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Badger Meter has total liabilities of US$58m and total assets of US$403m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Badger Meter's ROCE
With that in mind, Badger Meter's ROCE appears pretty good. Badger Meter shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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 firstname.lastname@example.org. 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.