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Why Mercury Systems, Inc.’s (NASDAQ:MRCY) Return On Capital Employed Looks Uninspiring

Today we'll look at Mercury Systems, Inc. (NASDAQ:MRCY) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

Understanding 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. All else being equal, a better business will have a higher ROCE. 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.

How Do You Calculate Return On Capital Employed?

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 Mercury Systems:

0.062 = US$87m ÷ (US$1.5b - US$108m) (Based on the trailing twelve months to December 2019.)

So, Mercury Systems has an ROCE of 6.2%.

View our latest analysis for Mercury Systems

Does Mercury Systems Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Mercury Systems's ROCE is meaningfully below the Aerospace & Defense industry average of 11%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Mercury Systems 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.

The image below shows how Mercury Systems's ROCE compares to its industry, and you can click it to see more detail on its past growth.

NasdaqGS:MRCY Past Revenue and Net Income April 7th 2020
NasdaqGS:MRCY Past Revenue and Net Income April 7th 2020

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.

How Mercury Systems'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.

Mercury Systems has total assets of US$1.5b and current liabilities of US$108m. Therefore its current liabilities are equivalent to approximately 7.1% of its total assets. Mercury Systems reports few current liabilities, which have a negligible impact on its unremarkable ROCE.

What We Can Learn From Mercury Systems's ROCE

Based on this information, Mercury Systems appears to be a mediocre business. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.