Today we'll evaluate Carpenter Technology Corporation (NYSE:CRS) 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. 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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'.
So, How Do We Calculate ROCE?
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 Carpenter Technology:
0.077 = US$206m ÷ (US$3.2b - US$498m) (Based on the trailing twelve months to December 2018.)
Therefore, Carpenter Technology has an ROCE of 7.7%.
Does Carpenter Technology Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Carpenter Technology's ROCE appears to be significantly below the 11% average in the Metals and Mining industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Carpenter Technology'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.
Our data shows that Carpenter Technology currently has an ROCE of 7.7%, compared to its ROCE of 5.0% 3 years ago. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Given the industry it operates in, Carpenter Technology could be considered cyclical. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Carpenter Technology's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Carpenter Technology has total assets of US$3.2b and current liabilities of US$498m. As a result, its current liabilities are equal to approximately 16% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Carpenter Technology's ROCE
If Carpenter Technology continues to earn an uninspiring ROCE, there may be better places to invest. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Carpenter Technology better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.