Today we’ll look at Versum Materials, Inc. (NYSE:VSM) and reflect on its potential as an investment. 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, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the 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 Versum Materials:
0.30 = US$395m ÷ (US$1.5b – US$188m) (Based on the trailing twelve months to September 2018.)
So, Versum Materials has an ROCE of 30%.
Does Versum Materials Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Versum Materials’s ROCE is meaningfully better than the 14% average in the Semiconductor industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Setting aside the comparison to its industry for a moment, Versum Materials’s ROCE in absolute terms currently looks quite high.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Versum Materials.
Do Versum Materials’s Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Versum Materials has total liabilities of US$188m and total assets of US$1.5b. As a result, its current liabilities are equal to approximately 12% of its total assets.
What We Can Learn From Versum Materials’s ROCE
The fairly low level of current liabilities won’t have much impact on the already great ROCE. With low current liabilities and a high ROCE, Versum Materials could be worthy of further investigation. We are impressed with ROCEs, but we look at other information, too. For example, I often check if insiders have been buying shares .
If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.
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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 email@example.com.