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Is Linamar Corporation (TSE:LNR) Investing Your Capital Efficiently?

Today we are going to look at Linamar Corporation (TSE:LNR) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

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

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. 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'.

How Do You Calculate Return On Capital Employed?

The formula for calculating the return on capital employed is:

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Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Linamar:

0.11 = CA$706m ÷ (CA$8.0b - CA$1.5b) (Based on the trailing twelve months to September 2019.)

Therefore, Linamar has an ROCE of 11%.

Check out our latest analysis for Linamar

Is Linamar's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Linamar's ROCE appears meaningfully below the 14% average reported by the Auto Components industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Linamar compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Linamar's current ROCE of 11% is lower than its ROCE in the past, which was 16%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Linamar's ROCE compares to its industry, and you can click it to see more detail on its past growth.

TSX:LNR Past Revenue and Net Income, January 30th 2020
TSX:LNR Past Revenue and Net Income, January 30th 2020

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Linamar.

How Linamar's Current Liabilities Impact Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Linamar has current liabilities of CA$1.5b and total assets of CA$8.0b. Therefore its current liabilities are equivalent to approximately 19% of its total assets. Low current liabilities are not boosting the ROCE too much.

Our Take On Linamar's ROCE

This is good to see, and with a sound ROCE, Linamar could be worth a closer look. Linamar 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.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.