Shareholders Should Look Hard At Covenant Transportation Group, Inc.’s (NASDAQ:CVTI) 2.1%Return On Capital
Today we are going to look at Covenant Transportation Group, Inc. (NASDAQ:CVTI) 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.
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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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 Covenant Transportation Group:
0.021 = US$16m ÷ (US$902m - US$153m) (Based on the trailing twelve months to December 2019.)
Therefore, Covenant Transportation Group has an ROCE of 2.1%.
See our latest analysis for Covenant Transportation Group
Is Covenant Transportation Group's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Covenant Transportation Group's ROCE is meaningfully below the Transportation industry average of 11%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Regardless of how Covenant Transportation Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.
Covenant Transportation Group's current ROCE of 2.1% is lower than 3 years ago, when the company reported a 6.2% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Covenant Transportation Group's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Covenant Transportation Group's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.
Covenant Transportation Group has current liabilities of US$153m and total assets of US$902m. Therefore its current liabilities are equivalent to approximately 17% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Covenant Transportation Group's ROCE
That's not a bad thing, however Covenant Transportation Group has a weak ROCE and may not be an attractive investment. You might be able to find a better investment than Covenant Transportation Group. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
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. Thank you for reading.
