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Is TransDigm Group Incorporated (NYSE:TDG) Investing Effectively In Its Business?

Simply Wall St

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Today we'll evaluate TransDigm Group Incorporated (NYSE:TDG) 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 of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. 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 measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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.'

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 TransDigm Group:

0.12 = US$1.9b ÷ (US$18b - US$1.7b) (Based on the trailing twelve months to March 2019.)

Therefore, TransDigm Group has an ROCE of 12%.

View our latest analysis for TransDigm Group

Is TransDigm Group's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see TransDigm Group's ROCE is around the 12% average reported by the Aerospace & Defense industry. Regardless of where TransDigm Group sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

TransDigm Group's current ROCE of 12% is lower than 3 years ago, when the company reported a 16% ROCE. This makes us wonder if the business is facing new challenges.

NYSE:TDG Past Revenue and Net Income, May 29th 2019

It is important to remember that ROCE shows past performance, and is 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for TransDigm Group.

TransDigm Group's Current Liabilities And Their Impact On 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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

TransDigm Group has total liabilities of US$1.7b and total assets of US$18b. Therefore its current liabilities are equivalent to approximately 9.7% of its total assets. With low current liabilities, TransDigm Group's decent ROCE looks that much more respectable.

The Bottom Line On TransDigm Group's ROCE

This is good to see, and while better prospects may exist, TransDigm Group seems worth researching further. TransDigm Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

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.