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Today we are going to look at VSE Corporation (NASDAQ:VSEC) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
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 VSE:
0.078 = US$54m ÷ (US$804m - US$120m) (Based on the trailing twelve months to March 2019.)
Therefore, VSE has an ROCE of 7.8%.
Is VSE's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, VSE's ROCE appears meaningfully below the 10% average reported by the Commercial Services industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how VSE stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
When considering this metric, keep in mind that it is backwards looking, and 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. If VSE is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
Do VSE's Current Liabilities Skew 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.
VSE has total liabilities of US$120m and total assets of US$804m. As a result, its current liabilities are equal to approximately 15% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From VSE's ROCE
With that in mind, we're not overly impressed with VSE's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than VSE. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.