Why We’re Not Impressed By Wabtec Corporation’s (NYSE:WAB) 5.3% ROCE
Today we are going to look at Wabtec Corporation (NYSE:WAB) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 Wabtec:
0.053 = US$831m ÷ (US$19b - US$3.2b) (Based on the trailing twelve months to June 2019.)
So, Wabtec has an ROCE of 5.3%.
Check out our latest analysis for Wabtec
Is Wabtec's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. We can see Wabtec's ROCE is meaningfully below the Machinery industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how Wabtec stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.
Wabtec's current ROCE of 5.3% is lower than 3 years ago, when the company reported a 21% ROCE. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Wabtec's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Wabtec.
Do Wabtec's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Wabtec has total liabilities of US$3.2b and total assets of US$19b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.
Our Take On Wabtec's ROCE
That's not a bad thing, however Wabtec has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.
