Today we are going to look at Standard Motor Products, Inc. (NYSE:SMP) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Standard Motor Products:
0.20 = US$119m ÷ (US$921m - US$330m) (Based on the trailing twelve months to September 2019.)
Therefore, Standard Motor Products has an ROCE of 20%.
Is Standard Motor Products's ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Standard Motor Products's ROCE is meaningfully higher than the 14% average in the Auto Components industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Standard Motor Products's ROCE currently appears to be excellent.
You can see in the image below how Standard Motor Products'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. 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 Standard Motor Products.
What Are Current Liabilities, And How Do They Affect Standard Motor Products's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Standard Motor Products has total assets of US$921m and current liabilities of US$330m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. A medium level of current liabilities boosts Standard Motor Products's ROCE somewhat.
The Bottom Line On Standard Motor Products's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Standard Motor Products 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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