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Today we’ll look at Arotech Corporation (NASDAQ:ARTX) 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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 Arotech:
0.052 = US$2.9m ÷ (US$116m – US$25m) (Based on the trailing twelve months to September 2018.)
Therefore, Arotech has an ROCE of 5.2%.
Does Arotech Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Arotech’s ROCE appears to be significantly below the 12% average in the Aerospace & Defense industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Arotech compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.7% available in government bonds. It is likely that there are more attractive prospects out there.
Arotech delivered an ROCE of 5.2%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.
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. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Arotech.
How Arotech’s Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Arotech has total assets of US$116m and current liabilities of US$25m. As a result, its current liabilities are equal to approximately 22% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From Arotech’s ROCE
That’s not a bad thing, however Arotech has a weak ROCE and may not be an attractive investment. You might be able to find a better buy than Arotech. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.