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Don’t Buy BorgWarner Inc. (NYSE:BWA) Until You Understand Its ROCE

Simply Wall St

Today we are going to look at BorgWarner Inc. (NYSE:BWA) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

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. 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'.

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 BorgWarner:

0.17 = US$1.3b ÷ (US$10b - US$2.4b) (Based on the trailing twelve months to December 2018.)

Therefore, BorgWarner has an ROCE of 17%.

View our latest analysis for BorgWarner

Does BorgWarner Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. It appears that BorgWarner's ROCE is fairly close to the Auto Components industry average of 15%. Regardless of where BorgWarner sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

NYSE:BWA Past Revenue and Net Income, April 15th 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How BorgWarner's Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

BorgWarner has total assets of US$10b and current liabilities of US$2.4b. Therefore its current liabilities are equivalent to approximately 24% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

Our Take On BorgWarner's ROCE

Overall, BorgWarner has a decent ROCE and could be worthy of further research. There might be better investments than BorgWarner 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 are like me, then you will not want to miss this free list of growing companies that insiders are 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 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. Thank you for reading.