Today we are going to look at Newater Technology, Inc. (NASDAQ:NEWA) 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. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Newater Technology:
0.35 = US$2.7m ÷ (US$67m – US$34m) (Based on the trailing twelve months to June 2018.)
Therefore, Newater Technology has an ROCE of 35%.
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Does Newater Technology Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Newater Technology’s ROCE is meaningfully higher than the 12% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Newater Technology’s ROCE is currently very good.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Newater Technology is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Newater Technology’s Current Liabilities And Their Impact On 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Newater Technology has total assets of US$67m and current liabilities of US$34m. Therefore its current liabilities are equivalent to approximately 51% of its total assets. Newater Technology boasts an attractive ROCE, even after considering the boost from high current liabilities.
What We Can Learn From Newater Technology’s ROCE
So to us, the company is potentially worth investigating further. You might be able to find a better buy than Newater Technology. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 email@example.com.