Today we'll look at Ferrotec Holdings Corporation (TYO:6890) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding 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. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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 Ferrotec Holdings:
0.05 = JP¥5.8b ÷ (JP¥180b - JP¥62b) (Based on the trailing twelve months to December 2019.)
Therefore, Ferrotec Holdings has an ROCE of 5.0%.
See our latest analysis for Ferrotec Holdings
Does Ferrotec Holdings Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Ferrotec Holdings's ROCE is meaningfully below the Semiconductor industry average of 9.2%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Ferrotec Holdings's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that, Ferrotec Holdings currently has an ROCE of 5.0%, less than the 11% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Ferrotec Holdings's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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 Ferrotec Holdings.
What Are Current Liabilities, And How Do They Affect Ferrotec Holdings's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Ferrotec Holdings has current liabilities of JP¥62b and total assets of JP¥180b. As a result, its current liabilities are equal to approximately 35% of its total assets. Ferrotec Holdings has a medium level of current liabilities, which would boost its ROCE somewhat.
What We Can Learn From Ferrotec Holdings's ROCE
Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. 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 Ferrotec Holdings 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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