Today we are going to look at Gentherm Incorporated (NASDAQ:THRM) to see whether it might be an attractive investment prospect. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. 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.'
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 Gentherm:
0.15 = US$90m ÷ (US$752m - US$161m) (Based on the trailing twelve months to June 2019.)
Therefore, Gentherm has an ROCE of 15%.
Does Gentherm Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that Gentherm's ROCE is fairly close to the Auto Components industry average of 15%. Regardless of where Gentherm sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Gentherm's current ROCE of 15% is lower than its ROCE in the past, which was 21%, 3 years ago. This makes us wonder if the business is facing new challenges. You can see in the image below how Gentherm'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. 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 Gentherm.
Gentherm's Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Gentherm has total assets of US$752m and current liabilities of US$161m. As a result, its current liabilities are equal to approximately 21% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Gentherm's ROCE
This is good to see, and with a sound ROCE, Gentherm could be worth a closer look. Gentherm shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
I will like Gentherm 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.