Today we’ll look at Ubiquiti Networks, Inc. (NASDAQ:UBNT) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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’.
So, How Do We Calculate ROCE?
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 Ubiquiti Networks:
0.54 = US$382m ÷ (US$936m – US$232m) (Based on the trailing twelve months to December 2018.)
Therefore, Ubiquiti Networks has an ROCE of 54%.
See our latest analysis for Ubiquiti Networks
Is Ubiquiti Networks’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Ubiquiti Networks’s ROCE is meaningfully better than the 8.4% average in the Communications 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. Setting aside the comparison to its industry for a moment, Ubiquiti Networks’s ROCE in absolute terms currently looks quite high.
In our analysis, Ubiquiti Networks’s ROCE appears to be 54%, compared to 3 years ago, when its ROCE was 35%. This makes us think the business might be improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Ubiquiti Networks’s 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Ubiquiti Networks has total liabilities of US$232m and total assets of US$936m. As a result, its current liabilities are equal to approximately 25% 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 Ubiquiti Networks’s ROCE
This is good to see, and with such a high ROCE, Ubiquiti Networks may be worth a closer look. You might be able to find a better buy than Ubiquiti Networks. 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).
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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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.