Why You Should Care About Taitron Components Incorporated’s (NASDAQ:TAIT) Low Return On Capital

Today we'll evaluate Taitron Components Incorporated (NASDAQ:TAIT) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

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 measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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:

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

Or for Taitron Components:

0.054 = US$698k ÷ (US$14m - US$784k) (Based on the trailing twelve months to December 2019.)

Therefore, Taitron Components has an ROCE of 5.4%.

Check out our latest analysis for Taitron Components

Does Taitron Components Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see Taitron Components's ROCE is meaningfully below the Electronic industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Taitron Components stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

Taitron Components delivered an ROCE of 5.4%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can see in the image below how Taitron Components's ROCE compares to its industry. Click to see more on 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 only a point-in-time measure. If Taitron Components is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

How Taitron Components's Current Liabilities Impact 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Taitron Components has current liabilities of US$784k and total assets of US$14m. Therefore its current liabilities are equivalent to approximately 5.8% of its total assets. Taitron Components reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

The Bottom Line On Taitron Components's ROCE

Based on this information, Taitron Components appears to be a mediocre business. 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.

I will like Taitron Components 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 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.