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Should You Worry About Power Integrations, Inc.’s (NASDAQ:POWI) ROCE?

Simply Wall St

Today we'll evaluate Power Integrations, Inc. (NASDAQ:POWI) to determine whether it could have potential as an investment idea. 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

How Do You Calculate Return On Capital Employed?

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 Power Integrations:

0.074 = US$42m ÷ (US$620m - US$55m) (Based on the trailing twelve months to June 2019.)

So, Power Integrations has an ROCE of 7.4%.

See our latest analysis for Power Integrations

Does Power Integrations Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Power Integrations's ROCE is meaningfully below the Semiconductor industry average of 10%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, Power Integrations's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Power Integrations's current ROCE of 7.4% is lower than its ROCE in the past, which was 9.9%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Power Integrations's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:POWI Past Revenue and Net Income, August 29th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Power Integrations's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.

Power Integrations has total liabilities of US$55m and total assets of US$620m. Therefore its current liabilities are equivalent to approximately 8.9% of its total assets. Power Integrations reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

Our Take On Power Integrations's ROCE

If performance improves, then Power Integrations may be an OK investment, especially at the right valuation. 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.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.