Today we are going to look at ALBA SE (FRA:ABA) to see whether it might be an attractive investment prospect. 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. Then we’ll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from 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.
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 ALBA:
0.014 = €2.2m ÷ (€202m – €45m) (Based on the trailing twelve months to June 2019.)
Therefore, ALBA has an ROCE of 1.4%.
Is ALBA’s ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, ALBA’s ROCE appears meaningfully below the 14% average reported by the Commercial Services industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside ALBA’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.
ALBA has an ROCE of 1.4%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That suggests the business has returned to profitability. The image below shows how ALBA’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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if ALBA has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
ALBA’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. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
ALBA has total assets of €202m and current liabilities of €45m. As a result, its current liabilities are equal to approximately 22% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.
What We Can Learn From ALBA’s ROCE
ALBA has a poor ROCE, and there may be better investment prospects out there. You might be able to find a better investment than ALBA. 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).
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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