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Don’t Buy PGT Innovations, Inc. (NYSE:PGTI) Until You Understand Its ROCE

Simply Wall St

Today we'll evaluate PGT Innovations, Inc. (NYSE:PGTI) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. 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. 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.'

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 Innovations:

0.12 = US$100m ÷ (US$922m - US$77m) (Based on the trailing twelve months to June 2019.)

So, Innovations has an ROCE of 12%.

Check out our latest analysis for Innovations

Is Innovations's ROCE Good?

One way to assess ROCE is to compare similar companies. It appears that Innovations's ROCE is fairly close to the Building industry average of 12%. Separate from Innovations's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

You can click on the image below to see (in greater detail) how Innovations's past growth compares to other companies.

NYSE:PGTI Past Revenue and Net Income, September 2nd 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.

Innovations'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. 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.

Innovations has total assets of US$922m and current liabilities of US$77m. As a result, its current liabilities are equal to approximately 8.3% of its total assets. With low current liabilities, Innovations's decent ROCE looks that much more respectable.

The Bottom Line On Innovations's ROCE

This is good to see, and while better prospects may exist, Innovations seems worth researching further. There might be better investments than Innovations 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.

I will like Innovations 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 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.