Today we’ll look at Cabot Microelectronics Corporation (NASDAQ:CCMP) and reflect on its potential as an investment. 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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 Cabot Microelectronics:
0.11 = US$228m ÷ (US$2.3b – US$155m) (Based on the trailing twelve months to June 2019.)
Therefore, Cabot Microelectronics has an ROCE of 11%.
Does Cabot Microelectronics Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Cabot Microelectronics’s ROCE is around the 10% average reported by the Semiconductor industry. Setting aside the industry comparison for now, Cabot Microelectronics’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.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Cabot Microelectronics’s Current Liabilities And Their Impact On 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. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Cabot Microelectronics has total liabilities of US$155m and total assets of US$2.3b. Therefore its current liabilities are equivalent to approximately 6.8% of its total assets. With low levels of current liabilities, at least Cabot Microelectronics’s mediocre ROCE is not unduly boosted.
Our Take On Cabot Microelectronics’s ROCE
Cabot Microelectronics looks like an ok business, but on this analysis it is not at the top of our buy list. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Cabot Microelectronics 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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