Today we are going to look at Applied Industrial Technologies, Inc. (NYSE:AIT) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First, 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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Applied Industrial Technologies:
0.14 = US$263m ÷ (US$2.3b – US$394m) (Based on the trailing twelve months to December 2018.)
Therefore, Applied Industrial Technologies has an ROCE of 14%.
Does Applied Industrial Technologies Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Applied Industrial Technologies’s ROCE is meaningfully better than the 8.2% average in the Trade Distributors industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Applied Industrial Technologies compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Applied Industrial Technologies.
What Are Current Liabilities, And How Do They Affect Applied Industrial Technologies’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Applied Industrial Technologies has total liabilities of US$394m and total assets of US$2.3b. As a result, its current liabilities are equal to approximately 17% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Applied Industrial Technologies’s ROCE
With that in mind, Applied Industrial Technologies’s ROCE appears pretty good. Applied Industrial Technologies looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.