Today we’ll evaluate Titan Machinery Inc. (NASDAQ:TITN) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we’ll look at what ROCE is and how we calculate it. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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 Titan Machinery:
0.08 = US$12m ÷ (US$825m – US$449m) (Based on the trailing twelve months to October 2018.)
So, Titan Machinery has an ROCE of 8.0%.
Is Titan Machinery’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Titan Machinery’s ROCE is around the 7.9% average reported by the Trade Distributors industry. Aside from the industry comparison, Titan Machinery’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.
Our data shows that Titan Machinery currently has an ROCE of 8.0%, compared to its ROCE of 4.6% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Titan Machinery.
What Are Current Liabilities, And How Do They Affect Titan Machinery’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. 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.
Titan Machinery has total assets of US$825m and current liabilities of US$449m. Therefore its current liabilities are equivalent to approximately 54% of its total assets. Titan Machinery has a fairly high level of current liabilities, meaningfully impacting its ROCE.
What We Can Learn From Titan Machinery’s ROCE
Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course you might be able to find a better stock than Titan Machinery. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list 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 email@example.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.