Today we'll evaluate Espey Mfg. & Electronics Corp. (NYSEMKT:ESP) 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Espey Mfg. & Electronics:
0.082 = US$2.7m ÷ (US$36m - US$3.5m) (Based on the trailing twelve months to June 2019.)
So, Espey Mfg. & Electronics has an ROCE of 8.2%.
Does Espey Mfg. & Electronics Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Espey Mfg. & Electronics's ROCE appears meaningfully below the 11% average reported by the Electrical industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Espey Mfg. & Electronics's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Espey Mfg. & Electronics's current ROCE of 8.2% is lower than 3 years ago, when the company reported a 13% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Espey Mfg. & Electronics's past growth compares to other companies.
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. ROCE is, after all, simply a snap shot of a single year. How cyclical is Espey Mfg. & Electronics? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Espey Mfg. & Electronics's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Espey Mfg. & Electronics has total assets of US$36m and current liabilities of US$3.5m. As a result, its current liabilities are equal to approximately 9.8% of its total assets. With low levels of current liabilities, at least Espey Mfg. & Electronics's mediocre ROCE is not unduly boosted.
Our Take On Espey Mfg. & Electronics's ROCE
If performance improves, then Espey Mfg. & Electronics may be an OK investment, especially at the right valuation. 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.
I will like Espey Mfg. & Electronics 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 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.