Why We’re Not Keen On Northwest Pipe Company’s (NASDAQ:NWPX) 7.3% Return On Capital

Today we are going to look at Northwest Pipe Company (NASDAQ:NWPX) to see whether it might be an attractive investment prospect. 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.

Firstly, 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 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. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.

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 Northwest Pipe:

0.073 = US$19m ÷ (US$285m – US$31m) (Based on the trailing twelve months to September 2019.)

So, Northwest Pipe has an ROCE of 7.3%.

View our latest analysis for Northwest Pipe

Does Northwest Pipe Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Northwest Pipe’s ROCE is meaningfully below the Construction industry average of 11%. 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, Northwest Pipe’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Northwest Pipe reported an ROCE of 7.3% — better than 3 years ago, when the company didn’t make a profit. This makes us wonder if the company is improving. You can see in the image below how Northwest Pipe’s ROCE compares to its industry. Click to see more on past growth.

NasdaqGS:NWPX Past Revenue and Net Income, January 22nd 2020
NasdaqGS:NWPX Past Revenue and Net Income, January 22nd 2020

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Northwest Pipe.

Northwest Pipe’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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.

Northwest Pipe has total assets of US$285m and current liabilities of US$31m. As a result, its current liabilities are equal to approximately 11% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

Our Take On Northwest Pipe’s ROCE

If Northwest Pipe continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.