Today we'll look at Huntington Ingalls Industries, Inc. (NYSE:HII) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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 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. 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 Huntington Ingalls Industries:
0.16 = US$859m ÷ (US$7.2b - US$1.9b) (Based on the trailing twelve months to June 2019.)
Therefore, Huntington Ingalls Industries has an ROCE of 16%.
Is Huntington Ingalls Industries's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Huntington Ingalls Industries's ROCE is meaningfully higher than the 10% average in the Aerospace & Defense industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Huntington Ingalls Industries's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Huntington Ingalls Industries's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Huntington Ingalls Industries.
How Huntington Ingalls Industries'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Huntington Ingalls Industries has total assets of US$7.2b and current liabilities of US$1.9b. As a result, its current liabilities are equal to approximately 26% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Huntington Ingalls Industries's ROCE
Overall, Huntington Ingalls Industries has a decent ROCE and could be worthy of further research. There might be better investments than Huntington Ingalls Industries out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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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.