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Why You Should Care About Tower Semiconductor Ltd.’s (NASDAQ:TSEM) Low Return On Capital

Simply Wall St

Today we’ll evaluate Tower Semiconductor Ltd. (NASDAQ:TSEM) 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.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding 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. Generally speaking a higher ROCE is better. 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 Tower Semiconductor:

0.098 = US$155m ÷ (US$1.8b – US$204m) (Based on the trailing twelve months to December 2018.)

So, Tower Semiconductor has an ROCE of 9.8%.

See our latest analysis for Tower Semiconductor

Does Tower Semiconductor Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Tower Semiconductor’s ROCE appears to be significantly below the 14% average in the Semiconductor industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Tower Semiconductor stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

NasdaqGS:TSEM Past Revenue and Net Income, March 1st 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 Tower Semiconductor.

How Tower Semiconductor’s Current Liabilities Impact Its 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Tower Semiconductor has total assets of US$1.8b and current liabilities of US$204m. As a result, its current liabilities are equal to approximately 11% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On Tower Semiconductor’s ROCE

That said, Tower Semiconductor’s ROCE is mediocre, there may be more attractive investments around. You might be able to find a better buy than Tower Semiconductor. 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.

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.