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Here’s why AerCap Holdings N.V.’s (NYSE:AER) Returns On Capital Matters So Much

Simply Wall St

Today we are going to look at AerCap Holdings N.V. (NYSE:AER) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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'.

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 AerCap Holdings:

0.058 = US$2.4b ÷ (US$45b - US$2.9b) (Based on the trailing twelve months to March 2019.)

So, AerCap Holdings has an ROCE of 5.8%.

See our latest analysis for AerCap Holdings

Does AerCap Holdings Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see AerCap Holdings's ROCE is meaningfully below the Trade Distributors industry average of 8.8%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, AerCap 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.

You can see in the image below how AerCap Holdings's ROCE compares to its industry. Click to see more on past growth.

NYSE:AER Past Revenue and Net Income, July 26th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for AerCap Holdings.

AerCap Holdings'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 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

AerCap Holdings has total liabilities of US$2.9b and total assets of US$45b. As a result, its current liabilities are equal to approximately 6.5% of its total assets. AerCap Holdings reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

What We Can Learn From AerCap Holdings's ROCE

If performance improves, then AerCap Holdings may be an OK investment, especially at the right valuation. Of course, you might also be able to find a better stock than AerCap Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.