Today we'll look at Héroux-Devtek Inc. (TSE:HRX) and reflect on its potential as an investment. 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.
Firstly, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. 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 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. Overall, it is a valuable metric that has its flaws. 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 Héroux-Devtek:
0.061 = CA$42m ÷ (CA$875m - CA$187m) (Based on the trailing twelve months to March 2019.)
So, Héroux-Devtek has an ROCE of 6.1%.
View our latest analysis for Héroux-Devtek
Does Héroux-Devtek Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In this analysis, Héroux-Devtek's ROCE appears meaningfully below the 10% average reported by the Aerospace & Defense industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Héroux-Devtek stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.
You can see in the image below how Héroux-Devtek's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Héroux-Devtek.
Do Héroux-Devtek'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 counter this, investors can check if a company has high current liabilities relative to total assets.