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Here’s why Charter Communications, Inc.’s (NASDAQ:CHTR) Returns On Capital Matters So Much

Kevin Zeng

Today we’ll look at Charter Communications, Inc. (NASDAQ:CHTR) and reflect on its potential as an investment. 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.

First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the 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 Charter Communications:

0.041 = US$4.6b ÷ (US$146b – US$12b) (Based on the trailing twelve months to September 2018.)

So, Charter Communications has an ROCE of 4.1%.

See our latest analysis for Charter Communications

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Does Charter Communications Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Charter Communications’s ROCE is meaningfully below the Media industry average of 8.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Charter Communications compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.

NASDAQGS:CHTR Last Perf January 29th 19

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. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Charter Communications.

Do Charter Communications’s Current Liabilities Skew 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Charter Communications has total assets of US$146b and current liabilities of US$12b. As a result, its current liabilities are equal to approximately 8.1% of its total assets. Charter Communications has a low level of current liabilities, which have a negligible impact on its already low ROCE.

What We Can Learn From Charter Communications’s ROCE

Nonetheless, there may be better places to invest your capital. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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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 editorial-team@simplywallst.com.