Methode Electronics, Inc. (NYSE:MEI) Earns A Nice Return On Capital Employed

Today we'll evaluate Methode Electronics, Inc. (NYSE:MEI) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

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 Methode Electronics:

0.13 = US$151m ÷ (US$1.3b - US$164m) (Based on the trailing twelve months to February 2020.)

So, Methode Electronics has an ROCE of 13%.

View our latest analysis for Methode Electronics

Is Methode Electronics's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Methode Electronics's ROCE appears to be substantially greater than the 11% average in the Electronic industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Methode Electronics's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

We can see that, Methode Electronics currently has an ROCE of 13%, less than the 22% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Methode Electronics's ROCE compares to its industry, and you can click it to see more detail on its past growth.

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Methode Electronics.

How Methode Electronics's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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.

Methode Electronics has current liabilities of US$164m and total assets of US$1.3b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.

The Bottom Line On Methode Electronics's ROCE

Overall, Methode Electronics has a decent ROCE and could be worthy of further research. Methode Electronics looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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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.

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