Today we are going to look at Ultralife Corporation (NASDAQ:ULBI) to see whether it might be an attractive investment prospect. 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 of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding 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. 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’.
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 Ultralife:
0.067 = US$8.6m ÷ (US$146m – US$19m) (Based on the trailing twelve months to March 2020.)
Therefore, Ultralife has an ROCE of 6.7%.
Is Ultralife’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Ultralife’s ROCE appears to be significantly below the 10% average in the Electrical industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Ultralife stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Ultralife’s ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. How cyclical is Ultralife? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Ultralife’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Ultralife has total assets of US$146m and current liabilities of US$19m. Therefore its current liabilities are equivalent to approximately 13% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Ultralife’s ROCE
If Ultralife continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better investment than Ultralife. 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).
Ultralife is not the only stock that insiders are buying. For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.