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What Can We Make Of Vector Group Ltd.’s (NYSE:VGR) High Return On Capital?

Simply Wall St

Today we'll evaluate Vector Group Ltd. (NYSE:VGR) 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 up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. Ultimately, it is a useful but imperfect metric. 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 Vector Group:

0.26 = US$237m ÷ (US$1.5b - US$558m) (Based on the trailing twelve months to June 2019.)

Therefore, Vector Group has an ROCE of 26%.

See our latest analysis for Vector Group

Is Vector Group's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Vector Group's ROCE appears to be substantially greater than the 16% average in the Tobacco industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, Vector Group's ROCE is currently very good.

The image below shows how Vector Group's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:VGR Past Revenue and Net Income, August 19th 2019

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 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 Vector Group.

Do Vector Group's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Vector Group has total assets of US$1.5b and current liabilities of US$558m. As a result, its current liabilities are equal to approximately 38% of its total assets. Vector Group's ROCE is boosted somewhat by its middling amount of current liabilities.

Our Take On Vector Group's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. Vector Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

I will like Vector Group 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 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.