Today we are going to look at ESCO Technologies Inc. (NYSE:ESE) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
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. 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?
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 ESCO Technologies:
0.095 = US$112m ÷ (US$1.4b - US$252m) (Based on the trailing twelve months to December 2019.)
Therefore, ESCO Technologies has an ROCE of 9.5%.
Does ESCO Technologies Have A Good ROCE?
One way to assess ROCE is to compare similar companies. It appears that ESCO Technologies's ROCE is fairly close to the Machinery industry average of 11%. Setting aside the industry comparison for now, ESCO Technologies's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
You can click on the image below to see (in greater detail) how ESCO Technologies's past growth compares to other companies.
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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do ESCO Technologies's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
ESCO Technologies has total assets of US$1.4b and current liabilities of US$252m. As a result, its current liabilities are equal to approximately 18% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
The Bottom Line On ESCO Technologies's ROCE
With that in mind, we're not overly impressed with ESCO Technologies's ROCE, so it may not be the most appealing prospect. You might be able to find a better investment than ESCO Technologies. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
I will like ESCO Technologies better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
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