Today we'll evaluate NVE Corporation (NASDAQ:NVEC) 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. 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 NVE:
0.18 = US$14m ÷ (US$82m - US$924k) (Based on the trailing twelve months to September 2019.)
So, NVE has an ROCE of 18%.
Is NVE's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that NVE's ROCE is meaningfully better than the 10% average in the Semiconductor industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where NVE sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how NVE's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. You can check if NVE has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do NVE's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
NVE has total liabilities of US$924k and total assets of US$82m. As a result, its current liabilities are equal to approximately 1.1% of its total assets. Low current liabilities have only a minimal impact on NVE's ROCE, making its decent returns more credible.
The Bottom Line On NVE's ROCE
This is good to see, and while better prospects may exist, NVE seems worth researching further. NVE 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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