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Why NETGEAR, Inc.’s (NASDAQ:NTGR) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we are going to look at NETGEAR, Inc. (NASDAQ:NTGR) to see whether it might be an attractive investment prospect. 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.

Firstly, we'll go over how we calculate ROCE. 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 amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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?

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 NETGEAR:

0.044 = US$29m ÷ (US$956m - US$298m) (Based on the trailing twelve months to December 2019.)

So, NETGEAR has an ROCE of 4.4%.

See our latest analysis for NETGEAR

Is NETGEAR's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, NETGEAR's ROCE appears meaningfully below the 6.0% average reported by the Communications industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside NETGEAR's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

NETGEAR's current ROCE of 4.4% is lower than 3 years ago, when the company reported a 13% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how NETGEAR's ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:NTGR Past Revenue and Net Income, March 15th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for NETGEAR.

How NETGEAR's Current Liabilities Impact 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.

NETGEAR has total assets of US$956m and current liabilities of US$298m. Therefore its current liabilities are equivalent to approximately 31% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, NETGEAR's ROCE is concerning.

The Bottom Line On NETGEAR's ROCE

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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.