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Shareholders Should Look Hard At NFI Group Inc.’s (TSE:NFI) 7.4%Return On Capital

Simply Wall St

Today we'll evaluate NFI Group Inc. (TSE:NFI) to determine whether it could have potential as an investment idea. 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, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?

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 NFI Group:

0.074 = US$172m ÷ (US$2.9b - US$631m) (Based on the trailing twelve months to September 2019.)

So, NFI Group has an ROCE of 7.4%.

See our latest analysis for NFI Group

Is NFI Group's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. We can see NFI Group's ROCE is meaningfully below the Machinery industry average of 9.7%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, NFI Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

We can see that, NFI Group currently has an ROCE of 7.4%, less than the 14% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how NFI Group's ROCE compares to its industry. Click to see more on past growth.

TSX:NFI Past Revenue and Net Income, December 5th 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. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How NFI Group's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

NFI Group has total assets of US$2.9b and current liabilities of US$631m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

What We Can Learn From NFI Group's ROCE

If NFI Group continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than NFI 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.