Today we'll evaluate Dialog Semiconductor Plc (ETR:DLG) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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?
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 Dialog Semiconductor:
0.24 = US$405m ÷ (US$2.3b - US$551m) (Based on the trailing twelve months to September 2019.)
So, Dialog Semiconductor has an ROCE of 24%.
Is Dialog Semiconductor's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Dialog Semiconductor's ROCE is meaningfully higher than the 12% average in the Semiconductor industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Dialog Semiconductor's ROCE is currently very good.
In our analysis, Dialog Semiconductor's ROCE appears to be 24%, compared to 3 years ago, when its ROCE was 17%. This makes us wonder if the company is improving. The image below shows how Dialog Semiconductor's ROCE compares to its industry, and you can click it to see more detail on its 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. 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 Dialog Semiconductor.
What Are Current Liabilities, And How Do They Affect Dialog Semiconductor's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Dialog Semiconductor has total assets of US$2.3b and current liabilities of US$551m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
Our Take On Dialog Semiconductor's ROCE
With low current liabilities and a high ROCE, Dialog Semiconductor could be worthy of further investigation. Dialog Semiconductor 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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