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Should You Worry About Altra Industrial Motion Corp.’s (NASDAQ:AIMC) ROCE?

Simply Wall St

Today we are going to look at Altra Industrial Motion Corp. (NASDAQ:AIMC) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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 Altra Industrial Motion:

0.064 = US$254m ÷ (US$4.3b - US$333m) (Based on the trailing twelve months to September 2019.)

Therefore, Altra Industrial Motion has an ROCE of 6.4%.

View our latest analysis for Altra Industrial Motion

Does Altra Industrial Motion Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Altra Industrial Motion's ROCE is meaningfully below the Machinery industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Altra Industrial Motion's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

Altra Industrial Motion's current ROCE of 6.4% is lower than its ROCE in the past, which was 13%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Altra Industrial Motion's ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:AIMC Past Revenue and Net Income, December 2nd 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Altra Industrial Motion.

Altra Industrial Motion'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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Altra Industrial Motion has total liabilities of US$333m and total assets of US$4.3b. As a result, its current liabilities are equal to approximately 7.8% of its total assets. With low levels of current liabilities, at least Altra Industrial Motion's mediocre ROCE is not unduly boosted.

What We Can Learn From Altra Industrial Motion's ROCE

Altra Industrial Motion looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might also be able to find a better stock than Altra Industrial Motion. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.