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Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) Might Not Be A Great Investment

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Today we are going to look at Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

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. Last but not least, we'll look at what impact its current liabilities have on 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. 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?

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 Kratos Defense & Security Solutions:

0.043 = US$43m ÷ (US$1.2b - US$182m) (Based on the trailing twelve months to September 2019.)

So, Kratos Defense & Security Solutions has an ROCE of 4.3%.

Check out our latest analysis for Kratos Defense & Security Solutions

Is Kratos Defense & Security Solutions's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Kratos Defense & Security Solutions's ROCE is meaningfully below the Aerospace & Defense industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Kratos Defense & Security Solutions compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. Readers may wish to look for more rewarding investments.

Kratos Defense & Security Solutions delivered an ROCE of 4.3%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability. The image below shows how Kratos Defense & Security Solutions's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:KTOS Past Revenue and Net Income, January 2nd 2020
NasdaqGS:KTOS Past Revenue and Net Income, January 2nd 2020

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Kratos Defense & Security Solutions.

How Kratos Defense & Security Solutions's Current Liabilities Impact 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.

Kratos Defense & Security Solutions has total assets of US$1.2b and current liabilities of US$182m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

Our Take On Kratos Defense & Security Solutions's ROCE

While that is good to see, Kratos Defense & Security Solutions has a low ROCE and does not look attractive in this analysis. Of course, you might also be able to find a better stock than Kratos Defense & Security Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.