Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we’ll look at ADT Inc. (NYSE:ADT) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 ADT:
0.02 = US$304m ÷ (US$17b – US$1.0b) (Based on the trailing twelve months to September 2018.)
Therefore, ADT has an ROCE of 2.0%.
Is ADT’s ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, ADT’s ROCE appears to be significantly below the 11% average in the Commercial Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Putting aside ADT’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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 ADT.
What Are Current Liabilities, And How Do They Affect ADT’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
ADT has total assets of US$17b and current liabilities of US$1.0b. As a result, its current liabilities are equal to approximately 6.0% of its total assets. ADT has a low level of current liabilities, which have a negligible impact on its already low ROCE.
Our Take On ADT’s ROCE
Nonetheless, there may be better places to invest your capital. Of course you might be able to find a better stock than ADT. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like ADT better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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 email@example.com.