Today we'll look at Nexteer Automotive Group Limited (HKG:1316) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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?
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 Nexteer Automotive Group:
0.18 = US$419m ÷ (US$3.1b - US$821m) (Based on the trailing twelve months to December 2018.)
So, Nexteer Automotive Group has an ROCE of 18%.
Does Nexteer Automotive Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Nexteer Automotive Group's ROCE is meaningfully higher than the 14% 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. Regardless of where Nexteer Automotive Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Nexteer Automotive Group's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 Nexteer Automotive Group.
How Nexteer Automotive Group'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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Nexteer Automotive Group has total liabilities of US$821m and total assets of US$3.1b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Nexteer Automotive Group's ROCE
With that in mind, Nexteer Automotive Group's ROCE appears pretty good. Nexteer Automotive Group 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 are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.