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Why We’re Not Keen On Cirrus Logic, Inc.’s (NASDAQ:CRUS) 7.7% Return On Capital

Simply Wall St

Today we'll evaluate Cirrus Logic, Inc. (NASDAQ:CRUS) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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'.

So, How Do We Calculate ROCE?

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 Cirrus Logic:

0.077 = US$96m ÷ (US$1.4b - US$116m) (Based on the trailing twelve months to March 2019.)

Therefore, Cirrus Logic has an ROCE of 7.7%.

See our latest analysis for Cirrus Logic

Is Cirrus Logic's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Cirrus Logic's ROCE appears meaningfully below the 11% average reported by the Semiconductor industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Cirrus Logic's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Cirrus Logic's current ROCE of 7.7% is lower than 3 years ago, when the company reported a 17% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Cirrus Logic's ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:CRUS Past Revenue and Net Income, July 22nd 2019

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cirrus Logic.

How Cirrus Logic's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Cirrus Logic has total assets of US$1.4b and current liabilities of US$116m. As a result, its current liabilities are equal to approximately 8.5% of its total assets. Cirrus Logic reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On Cirrus Logic's ROCE

If performance improves, then Cirrus Logic may be an OK investment, especially at the right valuation. You might be able to find a better investment than Cirrus Logic. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.