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Are ESCO Technologies Inc.’s Returns On Capital Worth Investigating?

Simply Wall St

Today we'll look at ESCO Technologies Inc. (NYSE:ESE) and reflect on its potential as an investment. 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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. 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 ESCO Technologies:

0.10 = US$117m ÷ (US$1.3b - US$200m) (Based on the trailing twelve months to June 2019.)

Therefore, ESCO Technologies has an ROCE of 10%.

Check out our latest analysis for ESCO Technologies

Does ESCO Technologies Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, ESCO Technologies's ROCE appears to be around the 11% average of the Machinery industry. Aside from the industry comparison, ESCO Technologies'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.

The image below shows how ESCO Technologies's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:ESE Past Revenue and Net Income, October 15th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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.

Do ESCO Technologies's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

ESCO Technologies has total assets of US$1.3b and current liabilities of US$200m. As a result, its current liabilities are equal to approximately 15% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On ESCO Technologies's ROCE

That said, ESCO Technologies's ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than ESCO Technologies. So you may wish to see this free collection of other companies that have grown earnings strongly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.