Today we are going to look at Verizon Communications Inc. (NYSE:VZ) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, 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.
What is Return On Capital Employed (ROCE)?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
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 Verizon Communications:
0.13 = US$32b ÷ (US$283b – US$38b) (Based on the trailing twelve months to June 2019.)
Therefore, Verizon Communications has an ROCE of 13%.
Does Verizon Communications Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Verizon Communications’s ROCE appears to be substantially greater than the 6.0% average in the Telecom industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Independently of how Verizon Communications compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that , Verizon Communications currently has an ROCE of 13%, less than the 17% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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.
Verizon Communications’s Current Liabilities And Their Impact On 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.
Verizon Communications has total liabilities of US$38b and total assets of US$283b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On Verizon Communications’s ROCE
With that in mind, Verizon Communications’s ROCE appears pretty good. Verizon Communications 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.
I will like Verizon Communications better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.