Here’s why Coherent, Inc.’s (NASDAQ:COHR) Returns On Capital Matters So Much

Today we’ll evaluate Coherent, Inc. (NASDAQ:COHR) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Coherent:

0.058 = US$107m ÷ (US$2.1b – US$240m) (Based on the trailing twelve months to September 2019.)

So, Coherent has an ROCE of 5.8%.

Check out our latest analysis for Coherent

Does Coherent Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Coherent’s ROCE appears meaningfully below the 12% average reported by the Electronic industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Aside from the industry comparison, Coherent’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.

Coherent’s current ROCE of 5.8% is lower than 3 years ago, when the company reported a 13% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Coherent’s ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:COHR Past Revenue and Net Income, January 15th 2020
NasdaqGS:COHR Past Revenue and Net Income, January 15th 2020

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. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Coherent.

How Coherent’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 counter this, investors can check if a company has high current liabilities relative to total assets.

Coherent has total liabilities of US$240m and total assets of US$2.1b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

The Bottom Line On Coherent’s ROCE

If Coherent continues to earn an uninspiring ROCE, there may be better places to invest. 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.

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.