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Today we are going to look at Seagate Technology plc (NASDAQ:STX) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect 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. Ultimately, it is a useful but imperfect metric. 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?
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 Seagate Technology:
0.29 = US$1.7b ÷ (US$8.8b – US$2.3b) (Based on the trailing twelve months to December 2018.)
Therefore, Seagate Technology has an ROCE of 29%.
Is Seagate Technology’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Seagate Technology’s ROCE is meaningfully better than the 12% average in the Tech industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Seagate Technology’s ROCE in absolute terms currently looks quite high.
In our analysis, Seagate Technology’s ROCE appears to be 29%, compared to 3 years ago, when its ROCE was 15%. This makes us wonder if the company is improving.
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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Seagate Technology.
Seagate Technology’s Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Seagate Technology has total assets of US$8.8b and current liabilities of US$2.3b. As a result, its current liabilities are equal to approximately 26% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Seagate Technology’s ROCE
Low current liabilities and high ROCE is a good combination, making Seagate Technology look quite interesting. 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.
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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 email@example.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.