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Today we are going to look at Vector Group Ltd. (NYSE:VGR) 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.
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.
Return On Capital Employed (ROCE): What is it?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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’.
How Do You Calculate Return On Capital Employed?
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 Vector Group:
0.29 = US$253m ÷ (US$1.3b – US$524m) (Based on the trailing twelve months to September 2018.)
Therefore, Vector Group has an ROCE of 29%.
Does Vector Group Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Vector Group’s ROCE appears to be substantially greater than the 14% average in the Tobacco industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Vector Group’s ROCE currently appears to be excellent.
As we can see, Vector Group currently has an ROCE of 29% compared to its ROCE 3 years ago, which was 20%. 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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Vector Group.
Do Vector Group’s Current Liabilities Skew 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. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Vector Group has total assets of US$1.3b and current liabilities of US$524m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. A medium level of current liabilities boosts Vector Group’s ROCE somewhat.
What We Can Learn From Vector Group’s ROCE
Even so, it has a great ROCE, and could be an attractive prospect for further research. But note: Vector Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
I will like Vector Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.