Today we'll evaluate ENGlobal Corporation (NASDAQ:ENG) to determine whether it could have potential as an investment idea. 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.
First, 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.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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. 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'.
How Do You Calculate Return On Capital Employed?
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 ENGlobal:
0.041 = US$692k ÷ (US$29m - US$12m) (Based on the trailing twelve months to March 2020.)
So, ENGlobal has an ROCE of 4.1%.
Is ENGlobal's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see ENGlobal's ROCE is meaningfully below the Energy Services industry average of 6.5%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside ENGlobal's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.
ENGlobal delivered an ROCE of 4.1%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving. You can see in the image below how ENGlobal's ROCE compares to its industry. Click to see more on past growth.
It is important to remember that ROCE shows past performance, and is 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. ROCE is, after all, simply a snap shot of a single year. Given the industry it operates in, ENGlobal could be considered cyclical. How cyclical is ENGlobal? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
How ENGlobal's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
ENGlobal has current liabilities of US$12m and total assets of US$29m. Therefore its current liabilities are equivalent to approximately 42% of its total assets. With a medium level of current liabilities boosting the ROCE a little, ENGlobal's low ROCE is unappealing.
What We Can Learn From ENGlobal's ROCE
There are likely better investments out there. You might be able to find a better investment than ENGlobal. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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.
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