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Why Napco Security Technologies, Inc.’s (NASDAQ:NSSC) Return On Capital Employed Is Impressive

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Today we are going to look at Napco Security Technologies, Inc. (NASDAQ:NSSC) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. 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.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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.

So, How Do We Calculate ROCE?

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 Napco Security Technologies:

0.19 = US$15m ÷ (US$97m - US$15m) (Based on the trailing twelve months to September 2019.)

Therefore, Napco Security Technologies has an ROCE of 19%.

Check out our latest analysis for Napco Security Technologies

Does Napco Security Technologies Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Napco Security Technologies's ROCE appears to be substantially greater than the 12% average in the Electronic 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 Napco Security Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Our data shows that Napco Security Technologies currently has an ROCE of 19%, compared to its ROCE of 12% 3 years ago. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Napco Security Technologies's past growth compares to other companies.

NasdaqGS:NSSC Past Revenue and Net Income, January 13th 2020
NasdaqGS:NSSC Past Revenue and Net Income, January 13th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Napco Security Technologies.

What Are Current Liabilities, And How Do They Affect Napco Security Technologies's ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Napco Security Technologies has total liabilities of US$15m and total assets of US$97m. As a result, its current liabilities are equal to approximately 15% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On Napco Security Technologies's ROCE

With that in mind, Napco Security Technologies's ROCE appears pretty good. There might be better investments than Napco Security Technologies 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.

I will like Napco Security Technologies better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.

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. Thank you for reading.