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Today we’ll look at Nexteer Automotive Group Limited (HKG:1316) 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, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. 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?
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 Nexteer Automotive Group:
0.18 = US$419m ÷ (US$3.1b – US$821m) (Based on the trailing twelve months to December 2018.)
Therefore, Nexteer Automotive Group has an ROCE of 18%.
Is Nexteer Automotive Group’s ROCE Good?
One way to assess ROCE is to compare similar companies. Nexteer Automotive Group’s ROCE appears to be substantially greater than the 14% average in the Auto Components industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Nexteer Automotive Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
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 Nexteer Automotive Group.
What Are Current Liabilities, And How Do They Affect Nexteer Automotive Group’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Nexteer Automotive Group has total liabilities of US$821m and total assets of US$3.1b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Nexteer Automotive Group’s ROCE
With that in mind, Nexteer Automotive Group’s ROCE appears pretty good. Nexteer Automotive Group shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Nexteer Automotive Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.