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Today we are going to look at Watts Water Technologies, Inc. (NYSE:WTS) 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.
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. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Watts Water Technologies:
0.14 = US$196m ÷ (US$1.7b - US$322m) (Based on the trailing twelve months to March 2019.)
Therefore, Watts Water Technologies has an ROCE of 14%.
Does Watts Water Technologies Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Watts Water Technologies's ROCE appears to be substantially greater than the 11% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Watts Water Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Watts Water Technologies's ROCE appears to be 14%, compared to 3 years ago, when its ROCE was 5.1%. This makes us think the business might be improving. You can see in the image below how Watts Water Technologies's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Watts Water Technologies.
Watts Water Technologies's Current Liabilities And Their Impact On 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Watts Water Technologies has total liabilities of US$322m and total assets of US$1.7b. As a result, its current liabilities are equal to approximately 19% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Watts Water Technologies's ROCE
This is good to see, and with a sound ROCE, Watts Water Technologies could be worth a closer look. Watts Water Technologies 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).
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 email@example.com. 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.