Today we'll look at Ingevity Corporation (NYSE:NGVT) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Ingevity:
0.15 = US$283m ÷ (US$2.1b - US$216m) (Based on the trailing twelve months to June 2019.)
So, Ingevity has an ROCE of 15%.
Is Ingevity's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Ingevity's ROCE is meaningfully better than the 10% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Ingevity compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Ingevity's current ROCE of 15% is lower than 3 years ago, when the company reported a 20% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Ingevity's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ingevity.
Ingevity's Current Liabilities And Their Impact On Its 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.
Ingevity has total assets of US$2.1b and current liabilities of US$216m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Ingevity's ROCE
Overall, Ingevity has a decent ROCE and could be worthy of further research. Ingevity looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.