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Today we are going to look at Texas Instruments Incorporated (NASDAQ:TXN) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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?
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 Texas Instruments:
0.42 = US$6.5b ÷ (US$17b – US$2.2b) (Based on the trailing twelve months to March 2019.)
Therefore, Texas Instruments has an ROCE of 42%.
Does Texas Instruments Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Texas Instruments’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 the industry comparison, in absolute terms, Texas Instruments’s ROCE currently appears to be excellent.
In our analysis, Texas Instruments’s ROCE appears to be 42%, compared to 3 years ago, when its ROCE was 32%. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Texas Instruments.
Texas Instruments’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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Texas Instruments has total liabilities of US$2.2b and total assets of US$17b. As a result, its current liabilities are equal to approximately 12% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Texas Instruments’s ROCE
Low current liabilities and high ROCE is a good combination, making Texas Instruments look quite interesting. There might be better investments than Texas Instruments 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.
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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 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.