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Today we are going to look at Texas Instruments Incorporated (NASDAQ:TXN) to see whether it might be an attractive investment prospect. 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. Then we'll compare its ROCE 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'
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 Texas Instruments:
0.45 = US$6.6b ÷ (US$17b - US$2.5b) (Based on the trailing twelve months to December 2018.)
So, Texas Instruments has an ROCE of 45%.
Is Texas Instruments's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that Texas Instruments's ROCE is meaningfully better than the 13% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Texas Instruments's ROCE is currently very good.
Our data shows that Texas Instruments currently has an ROCE of 45%, compared to its ROCE of 31% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Texas Instruments.
What Are Current Liabilities, And How Do They Affect Texas Instruments's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Texas Instruments has total assets of US$17b and current liabilities of US$2.5b. As a result, its current liabilities are equal to approximately 14% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Texas Instruments's ROCE
This is good to see, and with such a high ROCE, Texas Instruments may be worth a closer look. Of course you might be able to find a better stock than Texas Instruments. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 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.