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Today we are going to look at ON Semiconductor Corporation (NASDAQ:ON) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 ON Semiconductor:
0.14 = US$855m ÷ (US$7.6b - US$1.3b) (Based on the trailing twelve months to March 2019.)
So, ON Semiconductor has an ROCE of 14%.
Does ON Semiconductor Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. ON Semiconductor's ROCE appears to be substantially greater than the 11% average in the Semiconductor 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 ON Semiconductor sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
As we can see, ON Semiconductor currently has an ROCE of 14% compared to its ROCE 3 years ago, which was 10%. This makes us think the business might be improving.
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. 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.
How ON Semiconductor's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.
ON Semiconductor has total assets of US$7.6b and current liabilities of US$1.3b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On ON Semiconductor's ROCE
This is good to see, and with a sound ROCE, ON Semiconductor could be worth a closer look. ON Semiconductor 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.