Today we are going to look at Arotech Corporation (NASDAQ:ARTX) to see whether it might be an attractive investment prospect. 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. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from 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'.
How Do You Calculate Return On Capital Employed?
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 Arotech:
0.019 = US$1.8m ÷ (US$128m - US$34m) (Based on the trailing twelve months to June 2019.)
Therefore, Arotech has an ROCE of 1.9%.
Is Arotech's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Arotech's ROCE is meaningfully below the Aerospace & Defense industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Arotech compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
You can see in the image below how Arotech'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. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Arotech.
Do Arotech's Current Liabilities Skew 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. 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.
Arotech has total liabilities of US$34m and total assets of US$128m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
The Bottom Line On Arotech's ROCE
While that is good to see, Arotech has a low ROCE and does not look attractive in this analysis. 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).
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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 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. Thank you for reading.