Why We Like Autoliv, Inc.’s (NYSE:ALV) 20% Return On Capital Employed

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Today we'll look at Autoliv, Inc. (NYSE:ALV) 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.

Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding 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. Generally speaking a higher ROCE is better. 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?

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 Autoliv:

0.20 = US$822m ÷ (US$6.8b - US$2.7b) (Based on the trailing twelve months to March 2019.)

Therefore, Autoliv has an ROCE of 20%.

View our latest analysis for Autoliv

Is Autoliv's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Autoliv'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. Separate from Autoliv's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

In our analysis, Autoliv's ROCE appears to be 20%, compared to 3 years ago, when its ROCE was 16%. This makes us think about whether the company has been reinvesting shrewdly.

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our freereport on analyst forecasts for the company.

Do Autoliv's Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Autoliv has total assets of US$6.8b and current liabilities of US$2.7b. Therefore its current liabilities are equivalent to approximately 40% of its total assets. Autoliv has a middling amount of current liabilities, increasing its ROCE somewhat.

The Bottom Line On Autoliv's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Autoliv 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 freelist of growing companies with recent insider purchasing, could be just the ticket.

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 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. Thank you for reading.