Today we’ll look at Huntington Ingalls Industries, Inc. (NYSE:HII) and reflect on its potential as an investment. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.
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 Huntington Ingalls Industries:
0.15 = US$769m ÷ (US$7.2b – US$2.0b) (Based on the trailing twelve months to September 2019.)
So, Huntington Ingalls Industries has an ROCE of 15%.
See our latest analysis for Huntington Ingalls Industries
Does Huntington Ingalls Industries Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Huntington Ingalls Industries’s ROCE is meaningfully higher than the 11% average in the Aerospace & Defense industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Huntington Ingalls Industries’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Huntington Ingalls Industries’s ROCE compares to its industry. Click to see more on past growth.
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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
How Huntington Ingalls Industries’s Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Huntington Ingalls Industries has total assets of US$7.2b and current liabilities of US$2.0b. As a result, its current liabilities are equal to approximately 27% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Huntington Ingalls Industries’s ROCE
With that in mind, Huntington Ingalls Industries’s ROCE appears pretty good. Huntington Ingalls Industries 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.
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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.
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