Why We’re Not Keen On FARO Technologies, Inc.’s (NASDAQ:FARO) 1.3% Return On Capital

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Today we’ll look at FARO Technologies, Inc. (NASDAQ:FARO) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting 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. 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 FARO Technologies:

0.013 = US$5.4m ÷ (US$518m – US$93m) (Based on the trailing twelve months to March 2019.)

So, FARO Technologies has an ROCE of 1.3%.

View our latest analysis for FARO Technologies

Does FARO Technologies Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, FARO Technologies’s ROCE appears meaningfully below the 12% average reported by the Electronic industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of how FARO Technologies stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). There are potentially more appealing investments elsewhere.

FARO Technologies’s current ROCE of 1.3% is lower than 3 years ago, when the company reported a 4.3% ROCE. This makes us wonder if the business is facing new challenges.

NasdaqGS:FARO Past Revenue and Net Income, July 16th 2019
NasdaqGS:FARO Past Revenue and Net Income, July 16th 2019

When considering this metric, keep in mind that it is backwards looking, and 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 FARO Technologies.

What Are Current Liabilities, And How Do They Affect FARO Technologies’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.

FARO Technologies has total assets of US$518m and current liabilities of US$93m. Therefore its current liabilities are equivalent to approximately 18% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

What We Can Learn From FARO Technologies’s ROCE

While that is good to see, FARO Technologies has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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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 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.