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Why Echo Global Logistics, Inc.’s (NASDAQ:ECHO) Return On Capital Employed Might Be A Concern

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Today we'll look at Echo Global Logistics, Inc. (NASDAQ:ECHO) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?

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 Echo Global Logistics:

0.086 = US$53m ÷ (US$885m - US$267m) (Based on the trailing twelve months to March 2019.)

Therefore, Echo Global Logistics has an ROCE of 8.6%.

See our latest analysis for Echo Global Logistics

Is Echo Global Logistics's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, Echo Global Logistics's ROCE appears to be significantly below the 11% average in the Logistics industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Echo Global Logistics's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

As we can see, Echo Global Logistics currently has an ROCE of 8.6% compared to its ROCE 3 years ago, which was 3.6%. This makes us wonder if the company is improving.

NasdaqGS:ECHO Past Revenue and Net Income, May 31st 2019

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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Echo Global Logistics's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Echo Global Logistics has total liabilities of US$267m and total assets of US$885m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. Echo Global Logistics's middling level of current liabilities have the effect of boosting its ROCE a bit.

What We Can Learn From Echo Global Logistics's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.