U.S. Markets close in 6 hrs 6 mins

Why We’re Not Keen On Silicon Laboratories Inc.’s (NASDAQ:SLAB) 5.0% Return On Capital

Simply Wall St

Today we'll evaluate Silicon Laboratories Inc. (NASDAQ:SLAB) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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

0.05 = US$74m ÷ (US$1.6b - US$131m) (Based on the trailing twelve months to June 2019.)

Therefore, Silicon Laboratories has an ROCE of 5.0%.

See our latest analysis for Silicon Laboratories

Does Silicon Laboratories Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, Silicon Laboratories's ROCE appears meaningfully below the 10% 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. Independently of how Silicon Laboratories compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. There are potentially more appealing investments elsewhere.

You can see in the image below how Silicon Laboratories's ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:SLAB Past Revenue and Net Income, August 16th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 Silicon Laboratories.

Silicon Laboratories's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Silicon Laboratories has total assets of US$1.6b and current liabilities of US$131m. As a result, its current liabilities are equal to approximately 8.2% of its total assets. Silicon Laboratories has a low level of current liabilities, which have a negligible impact on its already low ROCE.

The Bottom Line On Silicon Laboratories's ROCE

Nonetheless, there may be better places to invest your capital. 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.

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.