Today we'll look at Daqo New Energy Corp. (NYSE:DQ) and reflect on its potential as an investment. 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. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is 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. 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?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Daqo New Energy:
0.063 = US$47m ÷ (US$1.2b - US$445m) (Based on the trailing twelve months to December 2019.)
So, Daqo New Energy has an ROCE of 6.3%.
Is Daqo New Energy's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Daqo New Energy's ROCE is meaningfully below the Semiconductor industry average of 8.4%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Daqo New Energy 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.
Daqo New Energy's current ROCE of 6.3% is lower than 3 years ago, when the company reported a 16% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how Daqo New Energy's past growth compares to other companies.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Daqo New Energy.
Do Daqo New Energy's Current Liabilities Skew 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Daqo New Energy has current liabilities of US$445m and total assets of US$1.2b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. Daqo New Energy's middling level of current liabilities have the effect of boosting its ROCE a bit.
Our Take On Daqo New Energy's ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might also be able to find a better stock than Daqo New Energy. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.