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Why TAT Technologies Ltd.’s (NASDAQ:TATT) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we are going to look at TAT Technologies Ltd. (NASDAQ:TATT) 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.

First, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?

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 TAT Technologies:

0.021 = US$2.0m ÷ (US$115m - US$21m) (Based on the trailing twelve months to December 2019.)

Therefore, TAT Technologies has an ROCE of 2.1%.

Check out our latest analysis for TAT Technologies

Is TAT Technologies's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see TAT Technologies's ROCE is meaningfully below the Aerospace & Defense industry average of 9.7%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how TAT Technologies stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). Readers may wish to look for more rewarding investments.

TAT Technologies's current ROCE of 2.1% is lower than its ROCE in the past, which was 4.3%, 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how TAT Technologies's past growth compares to other companies.

NasdaqGM:TATT Past Revenue and Net Income May 4th 2020

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. How cyclical is TAT Technologies? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

TAT Technologies's Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

TAT Technologies has current liabilities of US$21m and total assets of US$115m. As a result, its current liabilities are equal to approximately 18% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

The Bottom Line On TAT Technologies's ROCE

That's not a bad thing, however TAT Technologies 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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. Thank you for reading.