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Today we'll look at CPI Aerostructures, Inc. (NYSEMKT:CVU) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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 CPI Aerostructures:
0.088 = US$9.5m ÷ (US$154m - US$46m) (Based on the trailing twelve months to June 2019.)
Therefore, CPI Aerostructures has an ROCE of 8.8%.
Is CPI Aerostructures's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see CPI Aerostructures's ROCE is around the 11% average reported by the Aerospace & Defense industry. Setting aside the industry comparison for now, CPI Aerostructures's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
CPI Aerostructures delivered an ROCE of 8.8%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. You can click on the image below to see (in greater detail) how CPI Aerostructures'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for CPI Aerostructures.
How CPI Aerostructures's Current Liabilities Impact Its 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.
CPI Aerostructures has total liabilities of US$46m and total assets of US$154m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. CPI Aerostructures has a medium level of current liabilities, which would boost its ROCE somewhat.
Our Take On CPI Aerostructures's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.