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Why We Like NewMarket Corporation’s (NYSE:NEU) 23% Return On Capital Employed

Simply Wall St

Today we'll evaluate NewMarket Corporation (NYSE:NEU) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. 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.

What is 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. 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 NewMarket:

0.23 = US$347m ÷ (US$1.8b - US$283m) (Based on the trailing twelve months to June 2019.)

Therefore, NewMarket has an ROCE of 23%.

See our latest analysis for NewMarket

Is NewMarket's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that NewMarket's ROCE is meaningfully better than the 10% average in the Chemicals industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Putting aside its position relative to its industry for now, in absolute terms, NewMarket's ROCE is currently very good.

NewMarket's current ROCE of 23% is lower than 3 years ago, when the company reported a 33% ROCE. So investors might consider if it has had issues recently. The image below shows how NewMarket's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NYSE:NEU Past Revenue and Net Income, September 2nd 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. 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 NewMarket.

NewMarket's Current Liabilities And Their Impact On Its ROCE

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

NewMarket has total assets of US$1.8b and current liabilities of US$283m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. The fairly low level of current liabilities won't have much impact on the already great ROCE.

The Bottom Line On NewMarket's ROCE

This is good to see, and with such a high ROCE, NewMarket may be worth a closer look. There might be better investments than NewMarket 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).

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.