Today we'll evaluate Verizon Communications Inc. (NYSE:VZ) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
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. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 Verizon Communications:
0.13 = US$32b ÷ (US$285b - US$39b) (Based on the trailing twelve months to September 2019.)
Therefore, Verizon Communications has an ROCE of 13%.
Does Verizon Communications Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Verizon Communications's ROCE appears to be substantially greater than the 5.3% average in the Telecom industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Verizon Communications sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Verizon Communications's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and 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 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 Verizon Communications.
What Are Current Liabilities, And How Do They Affect Verizon Communications's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Verizon Communications has total assets of US$285b and current liabilities of US$39b. As a result, its current liabilities are equal to approximately 14% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Verizon Communications's ROCE
With that in mind, Verizon Communications's ROCE appears pretty good. Verizon Communications 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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