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Why You Should Care About Magal Security Systems Ltd.’s (NASDAQ:MAGS) Low Return On Capital

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Simply Wall St
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Today we are going to look at Magal Security Systems Ltd. (NASDAQ:MAGS) 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. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Magal Security Systems:

0.04 = US$3.8m ÷ (US$123m - US$29m) (Based on the trailing twelve months to September 2019.)

So, Magal Security Systems has an ROCE of 4.0%.

View our latest analysis for Magal Security Systems

Is Magal Security Systems's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Magal Security Systems'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. Independently of how Magal Security Systems compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. It is likely that there are more attractive prospects out there.

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

NasdaqGM:MAGS Past Revenue and Net Income, January 3rd 2020
NasdaqGM:MAGS Past Revenue and Net Income, January 3rd 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 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. If Magal Security Systems is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Magal Security Systems's Current Liabilities Impact Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Magal Security Systems has total assets of US$123m and current liabilities of US$29m. Therefore its current liabilities are equivalent to approximately 23% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

The Bottom Line On Magal Security Systems's ROCE

While that is good to see, Magal Security Systems has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Magal Security Systems. 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).

I will like Magal Security Systems better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.