Why We Like Teradyne, Inc.’s (NASDAQ:TER) 23% Return On Capital Employed

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Today we are going to look at Teradyne, Inc. (NASDAQ:TER) to see whether it might be an attractive investment prospect. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

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 Teradyne:

0.23 = US$492m ÷ (US$2.6b – US$442m) (Based on the trailing twelve months to March 2019.)

Therefore, Teradyne has an ROCE of 23%.

Check out our latest analysis for Teradyne

Does Teradyne Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Teradyne’s ROCE is meaningfully higher than the 12% 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. Setting aside the comparison to its industry for a moment, Teradyne’s ROCE in absolute terms currently looks quite high.

As we can see, Teradyne currently has an ROCE of 23% compared to its ROCE 3 years ago, which was 12%. This makes us think the business might be improving.

NasdaqGS:TER Past Revenue and Net Income, April 30th 2019
NasdaqGS:TER Past Revenue and Net Income, April 30th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Teradyne.

Teradyne’s Current Liabilities And Their Impact On 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. 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.

Teradyne has total assets of US$2.6b and current liabilities of US$442m. As a result, its current liabilities are equal to approximately 17% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

The Bottom Line On Teradyne’s ROCE

With low current liabilities and a high ROCE, Teradyne could be worthy of further investigation. There might be better investments than Teradyne 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.

I will like Teradyne 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 editorial-team@simplywallst.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.