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Why We Like STMicroelectronics N.V.’s (EPA:STM) 14% Return On Capital Employed

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Today we'll look at STMicroelectronics N.V. (EPA:STM) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, 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.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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'.

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 STMicroelectronics:

0.14 = US$1.3b ÷ (US$11b - US$2.1b) (Based on the trailing twelve months to March 2019.)

So, STMicroelectronics has an ROCE of 14%.

Check out our latest analysis for STMicroelectronics

Is STMicroelectronics's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. STMicroelectronics's ROCE appears to be substantially greater than the 9.9% average in the Semiconductor industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where STMicroelectronics sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.

Our data shows that STMicroelectronics currently has an ROCE of 14%, compared to its ROCE of 1.9% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how STMicroelectronics's ROCE compares to its industry. Click to see more on past growth.

ENXTPA:STM Past Revenue and Net Income, July 1st 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for STMicroelectronics.

Do STMicroelectronics'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.

STMicroelectronics has total liabilities of US$2.1b and total assets of US$11b. As a result, its current liabilities are equal to approximately 18% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From STMicroelectronics's ROCE

Overall, STMicroelectronics has a decent ROCE and could be worthy of further research. STMicroelectronics shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

I will like STMicroelectronics better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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 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.