Today we are going to look at Nexteer Automotive Group Limited (HKG:1316) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
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. Ultimately, it is a useful but imperfect metric. 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 Nexteer Automotive Group:
0.15 = US$344m ÷ (US$3.2b - US$819m) (Based on the trailing twelve months to June 2019.)
So, Nexteer Automotive Group has an ROCE of 15%.
Is Nexteer Automotive Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Nexteer Automotive Group's ROCE is meaningfully higher than the 12% average in the Auto Components industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Nexteer Automotive Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Nexteer Automotive Group's current ROCE of 15% is lower than 3 years ago, when the company reported a 23% ROCE. So investors might consider if it has had issues recently. The image below shows how Nexteer Automotive Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Nexteer Automotive Group's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Nexteer Automotive Group has current liabilities of US$819m and total assets of US$3.2b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Nexteer Automotive Group's ROCE
This is good to see, and with a sound ROCE, Nexteer Automotive Group could be worth a closer look. Nexteer Automotive Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at 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. Simply Wall St has no position in the stocks mentioned.
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