Today we’ll evaluate MKS Instruments, Inc. (NASDAQ:MKSI) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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?
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 MKS Instruments:
0.23 = US$423m ÷ (US$2.6b – US$262m) (Based on the trailing twelve months to September 2018.)
Therefore, MKS Instruments has an ROCE of 23%.
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Does MKS Instruments Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. MKS Instruments’s ROCE appears to be substantially greater than the 14% average in the Semiconductor industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, MKS Instruments’s ROCE in absolute terms currently looks quite high.
In our analysis, MKS Instruments’s ROCE appears to be 23%, compared to 3 years ago, when its ROCE was 15%. This makes us think the business might be improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for MKS Instruments.
How MKS Instruments’s Current Liabilities Impact Its 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.
MKS Instruments has total assets of US$2.6b and current liabilities of US$262m. As a result, its current liabilities are equal to approximately 10% of its total assets. The fairly low level of current liabilities won’t have much impact on the already great ROCE.
The Bottom Line On MKS Instruments’s ROCE
This is good to see, and with such a high ROCE, MKS Instruments may be worth a closer look. Of course you might be able to find a better stock than MKS Instruments. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.