Today we'll evaluate Ceragon Networks Ltd. (NASDAQ:CRNT) 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.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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?
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 Ceragon Networks:
0.081 = US$16m ÷ (US$302m - US$110m) (Based on the trailing twelve months to September 2019.)
Therefore, Ceragon Networks has an ROCE of 8.1%.
Is Ceragon Networks's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Ceragon Networks's ROCE appears to be around the 7.0% average of the Communications industry. Aside from the industry comparison, Ceragon Networks'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.
We can see that, Ceragon Networks currently has an ROCE of 8.1%, less than the 12% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Ceragon Networks's ROCE compares to its industry, and you can click it to see more detail on its 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Ceragon Networks.
Ceragon Networks'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ceragon Networks has total liabilities of US$110m and total assets of US$302m. As a result, its current liabilities are equal to approximately 36% of its total assets. Ceragon Networks has a medium level of current liabilities, which would boost its ROCE somewhat.
The Bottom Line On Ceragon Networks's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. 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).
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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