Today we'll look at SMART Global Holdings, Inc. (NASDAQ:SGH) and reflect on its potential as an investment. 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. 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. In general, businesses with a higher ROCE are usually better quality. 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'.
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 SMART Global Holdings:
0.097 = US$47m ÷ (US$783m - US$300m) (Based on the trailing twelve months to November 2019.)
So, SMART Global Holdings has an ROCE of 9.7%.
Does SMART Global Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that SMART Global Holdings's ROCE is fairly close to the Semiconductor industry average of 9.9%. Setting aside the industry comparison for now, SMART Global Holdings'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.
In our analysis, SMART Global Holdings's ROCE appears to be 9.7%, compared to 3 years ago, when its ROCE was 5.9%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how SMART Global Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for SMART Global Holdings.
How SMART Global Holdings's Current Liabilities Impact 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. 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.
SMART Global Holdings has total assets of US$783m and current liabilities of US$300m. Therefore its current liabilities are equivalent to approximately 38% of its total assets. SMART Global Holdings has a medium level of current liabilities, which would boost its ROCE somewhat.
The Bottom Line On SMART Global Holdings's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. Of course, you might also be able to find a better stock than SMART Global Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like SMART Global Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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