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Shareholders Should Look Hard At Kratos Defense & Security Solutions, Inc.’s (NASDAQ:KTOS) 3.7% Return On Capital

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Today we are going to look at Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Kratos Defense & Security Solutions:

0.037 = US$36m ÷ (US$1.2b - US$195m) (Based on the trailing twelve months to March 2019.)

So, Kratos Defense & Security Solutions has an ROCE of 3.7%.

Check out our latest analysis for Kratos Defense & Security Solutions

Is Kratos Defense & Security Solutions's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Kratos Defense & Security Solutions's ROCE appears to be significantly below the 12% 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. Putting aside Kratos Defense & Security Solutions's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. Readers may wish to look for more rewarding investments.

Kratos Defense & Security Solutions reported an ROCE of 3.7% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. The image below shows how Kratos Defense & Security Solutions's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:KTOS Past Revenue and Net Income, July 20th 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kratos Defense & Security Solutions.

Kratos Defense & Security Solutions'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Kratos Defense & Security Solutions has total liabilities of US$195m and total assets of US$1.2b. As a result, its current liabilities are equal to approximately 17% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

What We Can Learn From Kratos Defense & Security Solutions's ROCE

That's not a bad thing, however Kratos Defense & Security Solutions has a weak ROCE and may not be an attractive investment. Of course, you might also be able to find a better stock than Kratos Defense & Security Solutions. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 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. Thank you for reading.