Today we'll evaluate Woodward, Inc. (NASDAQ:WWD) 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.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Woodward:
0.11 = US$359m ÷ (US$4.0b - US$792m) (Based on the trailing twelve months to December 2019.)
So, Woodward has an ROCE of 11%.
Is Woodward's ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Woodward's ROCE is fairly close to the Machinery industry average of 11%. Independently of how Woodward compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can see in the image below how Woodward'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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Woodward.
How Woodward's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Woodward has current liabilities of US$792m and total assets of US$4.0b. As a result, its current liabilities are equal to approximately 20% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
What We Can Learn From Woodward's ROCE
With that in mind, Woodward's ROCE appears pretty good. There might be better investments than Woodward out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Woodward better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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