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Don’t Buy Advanced Micro Devices, Inc. (NASDAQ:AMD) Until You Understand Its ROCE

Simply Wall St

Today we'll evaluate Advanced Micro Devices, Inc. (NASDAQ:AMD) to determine whether it could have potential as an investment idea. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. 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.

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 Advanced Micro Devices:

0.11 = US$356m ÷ (US$5.3b - US$1.9b) (Based on the trailing twelve months to September 2019.)

Therefore, Advanced Micro Devices has an ROCE of 11%.

Check out our latest analysis for Advanced Micro Devices

Does Advanced Micro Devices Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that Advanced Micro Devices's ROCE is fairly close to the Semiconductor industry average of 9.9%. Regardless of where Advanced Micro Devices sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Advanced Micro Devices reported an ROCE of 11% -- better than 3 years ago, when the company didn't make a profit. That suggests the business has returned to profitability. You can see in the image below how Advanced Micro Devices's ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:AMD Past Revenue and Net Income, January 12th 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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, 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 Advanced Micro Devices.

What Are Current Liabilities, And How Do They Affect Advanced Micro Devices's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Advanced Micro Devices has total assets of US$5.3b and current liabilities of US$1.9b. Therefore its current liabilities are equivalent to approximately 35% of its total assets. With this level of current liabilities, Advanced Micro Devices's ROCE is boosted somewhat.

Our Take On Advanced Micro Devices's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Advanced Micro Devices 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.

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 editorial-team@simplywallst.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.

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. Thank you for reading.