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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. 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 amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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.’
So, How Do We Calculate ROCE?
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:
0.045 = US$3.9m ÷ (US$35m – US$4.2m) (Based on the trailing twelve months to December 2018.)
So, Espey Mfg. & Electronics has an ROCE of 4.5%.
Is Espey Mfg. & Electronics’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Espey Mfg. & Electronics’s ROCE appears to be significantly below the 11% average in the Electrical industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Espey Mfg. & Electronics compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Espey Mfg. & Electronics’s current ROCE of 4.5% is lower than its ROCE in the past, which was 13%, 3 years ago. Therefore we wonder if the company is facing new headwinds.
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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Espey Mfg. & Electronics.
What Are Current Liabilities, And How Do They Affect Espey Mfg. & Electronics’s 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.
Espey Mfg. & Electronics has total liabilities of US$4.2m and total assets of US$35m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
Our Take On Espey Mfg. & Electronics’s ROCE
That’s not a bad thing, however Espey Mfg. & Electronics has a weak ROCE and may not be an attractive investment. But note: Espey Mfg. & Electronics may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 email@example.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.