Today we’ll evaluate Garmin Ltd. (NASDAQ:GRMN) to determine whether it could have potential as an investment idea. 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. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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?
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 Garmin:
0.19 = US$892m ÷ (US$5.8b – US$1.0b) (Based on the trailing twelve months to September 2019.)
So, Garmin has an ROCE of 19%.
Is Garmin’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Garmin’s ROCE is meaningfully higher than the 12% average in the Consumer Durables industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Garmin’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how Garmin’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Garmin.
How Garmin’s Current Liabilities Impact 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Garmin has total assets of US$5.8b and current liabilities of US$1.0b. Therefore its current liabilities are equivalent to approximately 18% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Garmin’s ROCE
With that in mind, Garmin’s ROCE appears pretty good. Garmin looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at email@example.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.
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