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Why AerCap Holdings N.V.’s (NYSE:AER) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll evaluate AerCap Holdings N.V. (NYSE:AER) 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.

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. Finally, we'll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

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?

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 AerCap Holdings:

0.064 = US$2.6b ÷ (US$44b - US$2.9b) (Based on the trailing twelve months to September 2019.)

So, AerCap Holdings has an ROCE of 6.4%.

View our latest analysis for AerCap Holdings

Is AerCap Holdings's ROCE Good?

One way to assess ROCE is to compare similar companies. In this analysis, AerCap Holdings's ROCE appears meaningfully below the 9.4% average reported by the Trade Distributors industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, AerCap Holdings'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.

You can click on the image below to see (in greater detail) how AerCap Holdings's past growth compares to other companies.

NYSE:AER Past Revenue and Net Income, January 21st 2020

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for AerCap Holdings.

What Are Current Liabilities, And How Do They Affect AerCap Holdings's ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

AerCap Holdings has total liabilities of US$2.9b and total assets of US$44b. As a result, its current liabilities are equal to approximately 6.6% of its total assets. AerCap Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On AerCap Holdings's ROCE

AerCap Holdings looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.