Today we'll evaluate Onto Innovation Inc. (NYSE:ONTO) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Onto Innovation:
0.083 = US$34m ÷ (US$451m - US$46m) (Based on the trailing twelve months to September 2019.)
So, Onto Innovation has an ROCE of 8.3%.
Is Onto Innovation's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Onto Innovation's ROCE appears to be around the 9.9% average of the Semiconductor industry. Setting aside the industry comparison for now, Onto Innovation's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Onto Innovation's current ROCE of 8.3% is lower than its ROCE in the past, which was 12%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Onto Innovation's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Onto Innovation.
What Are Current Liabilities, And How Do They Affect Onto Innovation's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Onto Innovation has current liabilities of US$46m and total assets of US$451m. As a result, its current liabilities are equal to approximately 10% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
Our Take On Onto Innovation's ROCE
With that in mind, we're not overly impressed with Onto Innovation's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Onto Innovation. So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Onto Innovation better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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