Today we are going to look at Navistar International Corporation (NYSE:NAV) 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.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In the end, ROCE 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’.
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 Navistar International:
0.19 = US$638m ÷ (US$7.2b – US$3.8b) (Based on the trailing twelve months to October 2018.)
Therefore, Navistar International has an ROCE of 19%.
Is Navistar International’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Navistar International’s ROCE is meaningfully higher than the 12% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Navistar International compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
As we can see, Navistar International currently has an ROCE of 19% compared to its ROCE 3 years ago, which was 7.8%. This makes us think the business might be improving.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. 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. You can see analyst predictions in our free report on analyst forecasts for the company.
Navistar International’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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Navistar International has total liabilities of US$3.8b and total assets of US$7.2b. Therefore its current liabilities are equivalent to approximately 53% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
Our Take On Navistar International’s ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. The ROCE can give us an idea of the quality of a business, but we need to look deeper if we are considering a purchase. One data point to check is if insiders have bought shares recently.
Of course Navistar International 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 firstname.lastname@example.org.