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Today we’ll evaluate Vector Group Ltd. (NYSE:VGR) to determine whether it could have potential as an investment idea. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Vector Group:
0.20 = US$223m ÷ (US$1.4b – US$303m) (Based on the trailing twelve months to March 2019.)
So, Vector Group has an ROCE of 20%.
Does Vector Group Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Vector Group’s ROCE appears to be substantially greater than the 15% average in the Tobacco industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Vector Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Vector Group currently has an ROCE of 20%, less than the 27% it reported 3 years ago. This makes us wonder if the business is facing new challenges.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Vector Group.
Do Vector Group’s Current Liabilities Skew Its 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.
Vector Group has total liabilities of US$303m and total assets of US$1.4b. Therefore its current liabilities are equivalent to approximately 21% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Vector Group’s ROCE
With that in mind, Vector Group’s ROCE appears pretty good. Vector Group looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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.