Today we are going to look at AXT, Inc. (NASDAQ:AXTI) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed 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'.
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 AXT:
0.034 = US$6.7m ÷ (US$214m - US$17m) (Based on the trailing twelve months to June 2019.)
So, AXT has an ROCE of 3.4%.
Is AXT's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see AXT's ROCE is meaningfully below the Semiconductor industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how AXT stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.
AXT delivered an ROCE of 3.4%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. The image below shows how AXT's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect AXT's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
AXT has total assets of US$214m and current liabilities of US$17m. Therefore its current liabilities are equivalent to approximately 7.9% of its total assets. AXT has a low level of current liabilities, which have a negligible impact on its already low ROCE.
What We Can Learn From AXT's ROCE
Nonetheless, there may be better places to invest your capital. You might be able to find a better investment than AXT. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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If you spot an error that warrants correction, please contact the editor at email@example.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.