Today we are going to look at Chicago Rivet & Machine Co. (NYSEMKT:CVR) 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. 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. All else being equal, a better business will have a higher ROCE. 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.'
How Do You Calculate Return On Capital Employed?
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 Chicago Rivet & Machine:
0.078 = US$2.4m ÷ (US$33m - US$2.6m) (Based on the trailing twelve months to December 2018.)
Therefore, Chicago Rivet & Machine has an ROCE of 7.8%.
Is Chicago Rivet & Machine's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Chicago Rivet & Machine's ROCE appears meaningfully below the 11% average reported by the Machinery industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Chicago Rivet & Machine's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 Chicago Rivet & Machine is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do Chicago Rivet & Machine'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. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Chicago Rivet & Machine has total liabilities of US$2.6m and total assets of US$33m. Therefore its current liabilities are equivalent to approximately 7.7% of its total assets. Chicago Rivet & Machine has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.
The Bottom Line On Chicago Rivet & Machine's ROCE
Based on this information, Chicago Rivet & Machine appears to be a mediocre business. You might be able to find a better investment than Chicago Rivet & Machine. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like Chicago Rivet & Machine better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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.