Today we are going to look at Ducommun Incorporated (NYSE:DCO) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is 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. 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?
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 Ducommun:
0.089 = US$49m ÷ (US$680m - US$131m) (Based on the trailing twelve months to June 2019.)
Therefore, Ducommun has an ROCE of 8.9%.
Does Ducommun Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. We can see Ducommun's ROCE is around the 10% average reported by the Aerospace & Defense industry. Setting aside the industry comparison for now, Ducommun's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
In our analysis, Ducommun's ROCE appears to be 8.9%, compared to 3 years ago, when its ROCE was 3.3%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Ducommun's past growth compares to other companies.
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 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 Ducommun.
What Are Current Liabilities, And How Do They Affect Ducommun's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Ducommun has total liabilities of US$131m and total assets of US$680m. As a result, its current liabilities are equal to approximately 19% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Ducommun's ROCE
With that in mind, we're not overly impressed with Ducommun's ROCE, so it may not be the most appealing prospect. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.