Today we'll evaluate Newater Technology, Inc. (NASDAQ:NEWA) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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. 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 amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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.'
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:
0.28 = US$8.9m ÷ (US$62m - US$30m) (Based on the trailing twelve months to December 2018.)
So, Newater Technology has an ROCE of 28%.
Does Newater Technology Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Newater Technology's ROCE appears to be substantially greater than the 11% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Newater Technology's ROCE currently appears to be excellent.
We can see that , Newater Technology currently has an ROCE of 28%, less than the 41% it reported 3 years ago. So investors might consider if it has had issues recently. The image below shows how Newater Technology's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. You can check if Newater Technology has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do Newater Technology's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Newater Technology has total liabilities of US$30m and total assets of US$62m. As a result, its current liabilities are equal to approximately 49% of its total assets. Newater Technology has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From Newater Technology's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. Newater Technology shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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. Thank you for reading.