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Is Esterline Technologies Corporation (NYSE:ESL) Investing Your Capital Efficiently?

Simply Wall St

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Today we’ll look at Esterline Technologies Corporation (NYSE:ESL) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. 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.’

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 Esterline Technologies:

0.087 = US$230m ÷ (US$3.0b – US$378m) (Based on the trailing twelve months to December 2018.)

So, Esterline Technologies has an ROCE of 8.7%.

Check out our latest analysis for Esterline Technologies

Does Esterline Technologies Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Esterline Technologies’s ROCE appears meaningfully below the 12% average reported by the Aerospace & Defense industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Esterline Technologies stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

As we can see, Esterline Technologies currently has an ROCE of 8.7% compared to its ROCE 3 years ago, which was 5.4%. This makes us wonder if the company is improving.

NYSE:ESL Past Revenue and Net Income, March 25th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How Esterline Technologies’s Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Esterline Technologies has total assets of US$3.0b and current liabilities of US$378m. As a result, its current liabilities are equal to approximately 13% 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 Esterline Technologies’s ROCE

If Esterline Technologies continues to earn an uninspiring ROCE, there may be better places to invest. 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 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.