Today we are going to look at Coherent, Inc. (NASDAQ:COHR) 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, 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. In general, businesses with a higher ROCE are usually better quality. In the end, ROCE 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?
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 Coherent:
0.21 = US$394m ÷ (US$2.3b – US$373m) (Based on the trailing twelve months to September 2018.)
So, Coherent has an ROCE of 21%.
Does Coherent Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Coherent’s ROCE is meaningfully better than the 12% average in the Electronic industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Coherent compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Coherent’s ROCE appears to be 21%, compared to 3 years ago, when its ROCE was 12%. This makes us think about whether the company has been reinvesting shrewdly.
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. You can see analyst predictions in our free report on analyst forecasts for the company.
Do Coherent’s Current Liabilities Skew Its 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 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.
Coherent has total liabilities of US$373m and total assets of US$2.3b. Therefore its current liabilities are equivalent to approximately 16% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Coherent’s ROCE
Overall, Coherent has a decent ROCE and could be worthy of further research. You might be able to find a better buy than Coherent. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies.
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 email@example.com.