Today we’ll evaluate Innophos Holdings, Inc. (NASDAQ:IPHS) 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. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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’.
So, How Do We Calculate ROCE?
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 Innophos Holdings:
0.089 = US$67m ÷ (US$870m – US$119m) (Based on the trailing twelve months to June 2019.)
So, Innophos Holdings has an ROCE of 8.9%.
Does Innophos Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Innophos Holdings’s ROCE is around the 10% average reported by the Chemicals industry. Separate from how Innophos Holdings stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
The image below shows how Innophos Holdings’s ROCE compares to its industry.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the 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 Innophos Holdings.
What Are Current Liabilities, And How Do They Affect Innophos Holdings’s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Innophos Holdings has total liabilities of US$119m and total assets of US$870m. Therefore its current liabilities are equivalent to approximately 14% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Innophos Holdings’s ROCE
That said, Innophos Holdings’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Innophos Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 firstname.lastname@example.org. 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.