Today we'll evaluate Park Aerospace Corp. (NYSE:PKE) 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, we'll go over how we 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.
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. 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?
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 Park Aerospace:
0.062 = US$11m ÷ (US$185m - US$5.9m) (Based on the trailing twelve months to December 2019.)
So, Park Aerospace has an ROCE of 6.2%.
Is Park Aerospace's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Park Aerospace's ROCE appears to be significantly below the 11% average in the Aerospace & Defense industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Park Aerospace's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
In our analysis, Park Aerospace's ROCE appears to be 6.2%, compared to 3 years ago, when its ROCE was 4.2%. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Park Aerospace'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. If Park Aerospace is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Park Aerospace's Current Liabilities And Their Impact On Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Park Aerospace has total assets of US$185m and current liabilities of US$5.9m. As a result, its current liabilities are equal to approximately 3.2% of its total assets. With low levels of current liabilities, at least Park Aerospace's mediocre ROCE is not unduly boosted.
Our Take On Park Aerospace's ROCE
If performance improves, then Park Aerospace may be an OK investment, especially at the right valuation. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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