Today we’ll evaluate Northrop Grumman Corporation (NYSE:NOC) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared 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 is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, ROCE is a useful tool, but it is not without drawbacks. 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 Northrop Grumman:
0.13 = US$3.3b ÷ (US$38b – US$8.0b) (Based on the trailing twelve months to September 2018.)
Therefore, Northrop Grumman has an ROCE of 13%.
View our latest analysis for Northrop Grumman
Is Northrop Grumman’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Northrop Grumman’s ROCE appears to be around the 11% average of the Aerospace & Defense industry. Separate from Northrop Grumman’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Northrop Grumman.
How Northrop Grumman’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) unfairly boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Northrop Grumman has total assets of US$38b and current liabilities of US$8.0b. As a result, its current liabilities are equal to approximately 21% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Northrop Grumman’s ROCE
With that in mind, Northrop Grumman’s ROCE appears pretty good. Of course you might be able to find a better stock than Northrop Grumman. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity 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.