Don’t Buy Gentherm Incorporated (NASDAQ:THRM) Until You Understand Its ROCE

Today we'll evaluate Gentherm Incorporated (NASDAQ:THRM) 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. And finally, we'll look at how its current liabilities are impacting 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. 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 Gentherm:

0.15 = US$90m ÷ (US$752m - US$161m) (Based on the trailing twelve months to June 2019.)

So, Gentherm has an ROCE of 15%.

See our latest analysis for Gentherm

Is Gentherm's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Gentherm's ROCE appears to be around the 15% average of the Auto Components industry. Independently of how Gentherm compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

We can see that, Gentherm currently has an ROCE of 15%, less than the 21% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Gentherm's ROCE compares to its industry.

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 Gentherm.

Gentherm'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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Gentherm has total assets of US$752m and current liabilities of US$161m. As a result, its current liabilities are equal to approximately 21% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

What We Can Learn From Gentherm's ROCE

Overall, Gentherm has a decent ROCE and could be worthy of further research. There might be better investments than Gentherm out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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.