Today we’ll evaluate Nova Measuring Instruments Ltd. (NASDAQ:NVMI) 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.
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. 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’.
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 Nova Measuring Instruments:
0.11 = US$39m ÷ (US$400m – US$48m) (Based on the trailing twelve months to December 2019.)
So, Nova Measuring Instruments has an ROCE of 11%.
Does Nova Measuring Instruments Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that Nova Measuring Instruments’s ROCE is fairly close to the Semiconductor industry average of 9.6%. Independently of how Nova Measuring Instruments compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Nova Measuring Instruments’s past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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 Nova Measuring Instruments.
Do Nova Measuring Instruments’s Current Liabilities Skew 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. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Nova Measuring Instruments has total assets of US$400m and current liabilities of US$48m. Therefore its current liabilities are equivalent to approximately 12% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Nova Measuring Instruments’s ROCE
This is good to see, and with a sound ROCE, Nova Measuring Instruments could be worth a closer look. Nova Measuring Instruments shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Nova Measuring Instruments better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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