Today we’ll look at MagnaChip Semiconductor Corporation (NYSE:MX) 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.
First up, we’ll look at what ROCE is and how we calculate it. 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 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. 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.’
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 MagnaChip Semiconductor:
0.10 = US$36m ÷ (US$613m – US$160m) (Based on the trailing twelve months to September 2018.)
So, MagnaChip Semiconductor has an ROCE of 10%.
Does MagnaChip Semiconductor Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, MagnaChip Semiconductor’s ROCE appears meaningfully below the 14% average reported by the Semiconductor industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how MagnaChip Semiconductor 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.
MagnaChip Semiconductor delivered an ROCE of 10%, which is better than 3 years ago, as was making losses back then. That suggests the business has returned to profitability.
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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for MagnaChip Semiconductor.
Do MagnaChip Semiconductor’s Current Liabilities Skew 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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
MagnaChip Semiconductor has total assets of US$613m and current liabilities of US$160m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From MagnaChip Semiconductor’s ROCE
If MagnaChip Semiconductor continues to earn an uninspiring ROCE, there may be better places to invest. But note: MagnaChip Semiconductor 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org.