Today we'll evaluate Vectrus, Inc. (NYSE:VEC) 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 up, we'll look at what ROCE is and how we calculate it. 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 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. 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?
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 Vectrus:
0.15 = US$51m ÷ (US$572m - US$225m) (Based on the trailing twelve months to December 2018.)
So, Vectrus has an ROCE of 15%.
Is Vectrus's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Vectrus's ROCE appears to be substantially greater than the 12% average in the Aerospace & Defense industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Vectrus compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Vectrus.
What Are Current Liabilities, And How Do They Affect Vectrus's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Vectrus has total assets of US$572m and current liabilities of US$225m. As a result, its current liabilities are equal to approximately 39% of its total assets. With this level of current liabilities, Vectrus's ROCE is boosted somewhat.
What We Can Learn From Vectrus's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Vectrus 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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