Today we'll evaluate TPI Composites, Inc. (NASDAQ:TPIC) to determine whether it could have potential as an investment idea. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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'.
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 TPI Composites:
0.074 = US$25m ÷ (US$605m - US$270m) (Based on the trailing twelve months to December 2018.)
Therefore, TPI Composites has an ROCE of 7.4%.
Is TPI Composites's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In this analysis, TPI Composites's ROCE appears meaningfully below the 11% average reported by the Electrical industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, TPI Composites'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.
TPI Composites's current ROCE of 7.4% is lower than 3 years ago, when the company reported a 31% ROCE. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 TPI Composites.
How TPI Composites's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.
TPI Composites has total assets of US$605m and current liabilities of US$270m. As a result, its current liabilities are equal to approximately 45% of its total assets. TPI Composites's middling level of current liabilities have the effect of boosting its ROCE a bit.
What We Can Learn From TPI Composites's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than TPI Composites. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like TPI Composites better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 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.