Today we’ll evaluate EnPro Industries, Inc. (NYSE:NPO) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. 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’.
How Do You Calculate Return On Capital Employed?
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 EnPro Industries:
0.092 = US$118m ÷ (US$1.7b – US$260m) (Based on the trailing twelve months to September 2018.)
Therefore, EnPro Industries has an ROCE of 9.2%.
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Is EnPro Industries’s ROCE Good?
One way to assess ROCE is to compare similar companies. We can see EnPro Industries’s ROCE is meaningfully below the Machinery industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, EnPro Industries’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.
As we can see, EnPro Industries currently has an ROCE of 9.2% compared to its ROCE 3 years ago, which was 7.2%. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for EnPro Industries.
What Are Current Liabilities, And How Do They Affect EnPro Industries’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
EnPro Industries has total assets of US$1.7b and current liabilities of US$260m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
Our Take On EnPro Industries’s ROCE
With that in mind, we’re not overly impressed with EnPro Industries’s ROCE, so it may not be the most appealing prospect. But note: EnPro Industries 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 EnPro Industries better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.