Today we are going to look at Deswell Industries, Inc. (NASDAQ:DSWL) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed 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’.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Deswell Industries:
0.01 = US$1.9m ÷ (US$103m – US$19m) (Based on the trailing twelve months to September 2018.)
Therefore, Deswell Industries has an ROCE of 1.0%.
Is Deswell Industries’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Deswell Industries’s ROCE appears to be significantly below the 11% average in the Electronic industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside Deswell Industries’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
Deswell Industries has an ROCE of 1.0%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 only a point-in-time measure. If Deswell Industries is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Deswell Industries’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Deswell Industries has total assets of US$103m and current liabilities of US$19m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From Deswell Industries’s ROCE
While that is good to see, Deswell Industries has a low ROCE and does not look attractive in this analysis. Of course you might be able to find a better stock than Deswell Industries. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Deswell Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 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. Thank you for reading.