Today we’ll look at Garmin Ltd. (NASDAQ:GRMN) and reflect on its potential as an investment. 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. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. 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 Garmin:
0.18 = US$826m ÷ (US$5.5b – US$1.0b) (Based on the trailing twelve months to June 2019.)
Therefore, Garmin has an ROCE of 18%.
Is Garmin’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Garmin’s ROCE appears to be substantially greater than the 12% average in the Consumer Durables industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. 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.
You can click on the image below to see (in greater detail) how Garmin’s past growth compares to other companies.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Garmin.
What Are Current Liabilities, And How Do They Affect Garmin’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 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$5.5b and current liabilities of US$1.0b. As a result, its current liabilities are equal to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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