Today we'll look at CTS Corporation (NYSE:CTS) and reflect on its potential as an investment. 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. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 CTS:
0.12 = US$65m ÷ (US$648m - US$101m) (Based on the trailing twelve months to September 2019.)
Therefore, CTS has an ROCE of 12%.
Is CTS's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that CTS's ROCE is fairly close to the Electronic industry average of 12%. Separate from CTS's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how CTS's ROCE compares to its industry, and you can click it to see more detail on its past growth.
It is important to remember that ROCE shows past performance, and is 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 CTS.
What Are Current Liabilities, And How Do They Affect CTS's 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 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.
CTS has total liabilities of US$101m and total assets of US$648m. As a result, its current liabilities are equal to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On CTS's ROCE
With that in mind, CTS's ROCE appears pretty good. CTS shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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