Today we are going to look at Cognex Corporation (NASDAQ:CGNX) 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. Then we'll compare its ROCE to similar companies. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Cognex:
0.13 = US$170m ÷ (US$1.4b - US$81m) (Based on the trailing twelve months to September 2019.)
So, Cognex has an ROCE of 13%.
Does Cognex Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Cognex's ROCE is around the 12% average reported by the Electronic industry. Independently of how Cognex compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Cognex's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cognex.
What Are Current Liabilities, And How Do They Affect Cognex'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. 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.
Cognex has total liabilities of US$81m and total assets of US$1.4b. As a result, its current liabilities are equal to approximately 5.8% of its total assets. Low current liabilities have only a minimal impact on Cognex's ROCE, making its decent returns more credible.
Our Take On Cognex's ROCE
This is good to see, and while better prospects may exist, Cognex seems worth researching further. There might be better investments than Cognex 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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