Here’s why ON Semiconductor Corporation’s (NASDAQ:ON) Returns On Capital Matters So Much

Today we are going to look at ON Semiconductor Corporation (NASDAQ:ON) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. In brief, ROCE 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 ON Semiconductor:

0.13 = US$728m ÷ (US$7.4b - US$1.3b) (Based on the trailing twelve months to September 2018.)

Therefore, ON Semiconductor has an ROCE of 13%.

Check out our latest analysis for ON Semiconductor

Is ON Semiconductor's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. It appears that ON Semiconductor's ROCE is fairly close to the Semiconductor industry average of 14%. Independently of how ON Semiconductor compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

In our analysis, ON Semiconductor's ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 11%. This makes us wonder if the company is improving.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. You can see analyst predictions in our freereport on analyst forecasts for the company.

Do ON Semiconductor'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) unfairly boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

ON Semiconductor has total liabilities of US$1.3b and total assets of US$7.4b. As a result, its current liabilities are equal to approximately 18% of its total assets.

The Bottom Line On ON Semiconductor's ROCE

Low current liabilities are not boosting the ROCE too much. Overall, ON Semiconductor has a decent ROCE and could be worthy of further research. While the ROCE is useful information, it is not always predictive. We need to do more work before making a decision. One data point to check is if insiders have bought shares recently.

But note: ON Semiconductor may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.