Yahoo Finance Why You Should Care About Colfax Corporation’s (NYSE:CFX) Low Return On Capital
Today we'll evaluate Colfax Corporation (NYSE:CFX) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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 Colfax:
0.041 = US$269m ÷ (US$7.4b - US$857m) (Based on the trailing twelve months to December 2019.)
Therefore, Colfax has an ROCE of 4.1%.
Check out our latest analysis for Colfax
Does Colfax Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Colfax's ROCE appears to be significantly below the 11% average in the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Independently of how Colfax compares to its industry, its ROCE in absolute terms is low; especially compared to the ~1.7% available in government bonds. It is likely that there are more attractive prospects out there.
Colfax's current ROCE of 4.1% is lower than 3 years ago, when the company reported a 5.5% ROCE. This makes us wonder if the business is facing new challenges. The image below shows how Colfax's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 Colfax.
How Colfax's Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Colfax has current liabilities of US$857m and total assets of US$7.4b. Therefore its current liabilities are equivalent to approximately 12% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
Our Take On Colfax's ROCE
Colfax has a poor ROCE, and there may be better investment prospects out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
