Why We’re Not Keen On Jacobs Engineering Group Inc.’s (NYSE:JEC) 7.1% Return On Capital

Today we are going to look at Jacobs Engineering Group Inc. (NYSE:JEC) 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 up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. 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.’

So, How Do We Calculate ROCE?

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 Jacobs Engineering Group:

0.071 = US$679m ÷ (US$13b – US$3.1b) (Based on the trailing twelve months to September 2018.)

So, Jacobs Engineering Group has an ROCE of 7.1%.

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Is Jacobs Engineering Group’s ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, Jacobs Engineering Group’s ROCE appears to be significantly below the 9.8% average in the Construction industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Setting aside the industry comparison for now, Jacobs Engineering Group’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.

Jacobs Engineering Group’s current ROCE of 7.1% is lower than 3 years ago, when the company reported a 10% ROCE. This makes us wonder if the business is facing new challenges.

NYSE:JEC Last Perf January 23rd 19
NYSE:JEC Last Perf January 23rd 19

It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Jacobs Engineering Group.

Jacobs Engineering Group’s Current Liabilities And Their Impact On 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 the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Jacobs Engineering Group has total liabilities of US$3.1b and total assets of US$13b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Jacobs Engineering Group’s ROCE

That said, Jacobs Engineering Group’s ROCE is mediocre, there may be more attractive investments around. Of course you might be able to find a better stock than Jacobs Engineering Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.