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Why You Should Care About AerCap Holdings N.V.’s (NYSE:AER) Low Return On Capital

Today we’ll evaluate AerCap Holdings N.V. (NYSE:AER) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we’ll go over how we 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.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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’.

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 AerCap Holdings:

0.06 = US\$2.4b ÷ (US\$42b – US\$2.8b) (Based on the trailing twelve months to September 2018.)

Therefore, AerCap Holdings has an ROCE of 6.0%.

Is AerCap Holdings’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, AerCap Holdings’s ROCE appears to be significantly below the 7.9% average in the Trade Distributors industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, AerCap Holdings’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. You can see analyst predictions in our free report on analyst forecasts for the company.

AerCap Holdings’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. 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.

AerCap Holdings has total assets of US\$42b and current liabilities of US\$2.8b. As a result, its current liabilities are equal to approximately 6.7% of its total assets. AerCap Holdings has a low level of current liabilities, which have a minimal impact on its uninspiring ROCE.

The Bottom Line On AerCap Holdings’s ROCE

If performance improves, then AerCap Holdings may be an OK investment, especially at the right valuation. But note: AerCap Holdings may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

Of course AerCap Holdings may not be the best stock to buy. So you may wish to see this free collection of other companies that have high ROE and low debt.

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 editorial-team@simplywallst.com.