Today we'll evaluate nLIGHT, Inc. (NASDAQ:LASR) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. 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.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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'.
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 nLIGHT:
0.0056 = US$1.3m ÷ (US$255m - US$26m) (Based on the trailing twelve months to September 2019.)
Therefore, nLIGHT has an ROCE of 0.6%.
Does nLIGHT Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see nLIGHT's ROCE is meaningfully below the Electronic industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how nLIGHT compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. Readers may wish to look for more rewarding investments.
You can see in the image below how nLIGHT's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for nLIGHT.
nLIGHT'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. 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.
nLIGHT has total assets of US$255m and current liabilities of US$26m. As a result, its current liabilities are equal to approximately 10% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From nLIGHT's ROCE
That's not a bad thing, however nLIGHT has a weak ROCE and may not be an attractive investment. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like nLIGHT better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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