Today we'll evaluate Micron Technology, Inc. (NASDAQ:MU) to determine whether it could have potential as an investment idea. 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. 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 '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?
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 Micron Technology:
0.058 = US$2.6b ÷ (US$50b - US$5.8b) (Based on the trailing twelve months to February 2020.)
Therefore, Micron Technology has an ROCE of 5.8%.
Does Micron Technology Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. We can see Micron Technology's ROCE is meaningfully below the Semiconductor industry average of 8.7%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Micron Technology's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
You can see in the image below how Micron Technology's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Micron Technology's Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Micron Technology has total assets of US$50b and current liabilities of US$5.8b. As a result, its current liabilities are equal to approximately 12% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On Micron Technology's ROCE
If Micron Technology continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Micron Technology. 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 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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