Today we'll look at Allison Transmission Holdings, Inc. (NYSE:ALSN) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Allison Transmission Holdings:
0.24 = US$950m ÷ (US$4.5b - US$477m) (Based on the trailing twelve months to September 2019.)
So, Allison Transmission Holdings has an ROCE of 24%.
Does Allison Transmission Holdings Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Allison Transmission Holdings's ROCE is meaningfully higher than the 11% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Allison Transmission Holdings's ROCE in absolute terms currently looks quite high.
In our analysis, Allison Transmission Holdings's ROCE appears to be 24%, compared to 3 years ago, when its ROCE was 12%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Allison Transmission Holdings's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. 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 Allison Transmission Holdings.
How Allison Transmission Holdings'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 counter this, investors can check if a company has high current liabilities relative to total assets.
Allison Transmission Holdings has total assets of US$4.5b and current liabilities of US$477m. As a result, its current liabilities are equal to approximately 11% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Allison Transmission Holdings's ROCE
This is good to see, and with such a high ROCE, Allison Transmission Holdings may be worth a closer look. Allison Transmission Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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