Today we are going to look at Modine Manufacturing Company (NYSE:MOD) to see whether it might be an attractive investment prospect. 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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'.
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 Modine Manufacturing:
0.059 = US$63m ÷ (US$1.5b - US$474m) (Based on the trailing twelve months to December 2019.)
Therefore, Modine Manufacturing has an ROCE of 5.9%.
Is Modine Manufacturing's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Modine Manufacturing's ROCE appears to be significantly below the 11% average in the Auto Components industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Modine Manufacturing stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
In our analysis, Modine Manufacturing's ROCE appears to be 5.9%, compared to 3 years ago, when its ROCE was 1.3%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Modine Manufacturing's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Modine Manufacturing.
What Are Current Liabilities, And How Do They Affect Modine Manufacturing's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Modine Manufacturing has total assets of US$1.5b and current liabilities of US$474m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Modine Manufacturing's ROCE is improved somewhat by its moderate amount of current liabilities.
The Bottom Line On Modine Manufacturing's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than Modine Manufacturing. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.