Today we'll look at Commercial Vehicle Group, Inc. (NASDAQ:CVGI) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to 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. In brief, it is a useful tool, but it is not without drawbacks. 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'.
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 Commercial Vehicle Group:
0.19 = US$63m ÷ (US$471m - US$137m) (Based on the trailing twelve months to September 2019.)
Therefore, Commercial Vehicle Group has an ROCE of 19%.
Does Commercial Vehicle Group Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Commercial Vehicle Group's ROCE appears to be substantially greater than the 11% average in the Machinery industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Commercial Vehicle Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Commercial Vehicle Group's ROCE appears to be 19%, compared to 3 years ago, when its ROCE was 9.3%. This makes us think the business might be improving. You can see in the image below how Commercial Vehicle Group's ROCE compares to its industry. Click to see more on past growth.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Commercial Vehicle Group.
Commercial Vehicle Group's Current Liabilities And Their Impact On 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.
Commercial Vehicle Group has total liabilities of US$137m and total assets of US$471m. As a result, its current liabilities are equal to approximately 29% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Commercial Vehicle Group's ROCE
With that in mind, Commercial Vehicle Group's ROCE appears pretty good. There might be better investments than Commercial Vehicle Group out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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