Today we are going to look at Knowles Corporation (NYSE:KN) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting 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. In general, businesses with a higher ROCE are usually better quality. 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.’
How Do You Calculate Return On Capital Employed?
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 Knowles:
0.063 = US$79m ÷ (US$1.6b – US$148m) (Based on the trailing twelve months to September 2018.)
Therefore, Knowles has an ROCE of 6.3%.
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Does Knowles Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Knowles’s ROCE appears to be significantly below the 12% average in the Electronic industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Knowles stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
As we can see, Knowles currently has an ROCE of 6.3% compared to its ROCE 3 years ago, which was 3.9%. This makes us wonder if the company is improving.
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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Knowles.
Knowles’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 counter this, investors can check if a company has high current liabilities relative to total assets.
Knowles has total liabilities of US$148m and total assets of US$1.6b. Therefore its current liabilities are equivalent to approximately 9.4% of its total assets. Knowles reports few current liabilities, which have a negligible impact on its unremarkable ROCE.
What We Can Learn From Knowles’s ROCE
If performance improves, then Knowles may be an OK investment, especially at the right valuation. Of course you might be able to find a better stock than Knowles. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.