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Today we’ll look at NVE Corporation (NASDAQ:NVEC) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 NVE:
0.19 = US$16m ÷ (US$84m – US$836k) (Based on the trailing twelve months to March 2019.)
So, NVE has an ROCE of 19%.
Does NVE Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. NVE’s ROCE appears to be substantially greater than the 11% average in the Semiconductor industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of where NVE sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If NVE is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
NVE’s Current Liabilities And Their Impact On 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) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
NVE has total liabilities of US$836k and total assets of US$84m. As a result, its current liabilities are equal to approximately 1.0% of its total assets. In addition to low current liabilities (making a negligible impact on ROCE), NVE earns a sound return on capital employed.
The Bottom Line On NVE’s ROCE
If it is able to keep this up, NVE could be attractive. There might be better investments than NVE out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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. Thank you for reading.