Today we are going to look at Ubiquiti Networks, Inc. (NASDAQ:UBNT) to see whether it might be an attractive investment prospect. 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. 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 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?
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 Ubiquiti Networks:
0.40 = US$326m ÷ (US$1.0b – US$152m) (Based on the trailing twelve months to September 2018.)
Therefore, Ubiquiti Networks has an ROCE of 40%.
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Is Ubiquiti Networks’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Ubiquiti Networks’s ROCE is meaningfully higher than the 7.5% average in the Communications industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Ubiquiti Networks’s ROCE in absolute terms currently looks quite high.
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 Ubiquiti Networks.
Ubiquiti Networks’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ubiquiti Networks has total assets of US$1.0b and current liabilities of US$152m. As a result, its current liabilities are equal to approximately 15% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Ubiquiti Networks’s ROCE
Low current liabilities and high ROCE is a good combination, making Ubiquiti Networks look quite interesting. Of course you might be able to find a better stock than Ubiquiti Networks. So you may wish to see this free collection of other companies that have grown earnings strongly.
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.