Today we’ll look at DEUTZ Aktiengesellschaft (ETR:DEZ) 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. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
What is 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.
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 DEUTZ:
0.11 = €93m ÷ (€1.3b – €406m) (Based on the trailing twelve months to September 2019.)
So, DEUTZ has an ROCE of 11%.
Does DEUTZ Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, DEUTZ’s ROCE appears to be around the 9.3% average of the Machinery industry. Independently of how DEUTZ compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that DEUTZ currently has an ROCE of 11%, compared to its ROCE of 1.9% 3 years ago. This makes us think the business might be improving. You can see in the image below how DEUTZ’s ROCE compares to its industry.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for DEUTZ.
How DEUTZ’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 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.
DEUTZ has total liabilities of €406m and total assets of €1.3b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. With this level of current liabilities, DEUTZ’s ROCE is boosted somewhat.
What We Can Learn From DEUTZ’s ROCE
DEUTZ’s ROCE does look good, but the level of current liabilities also contribute to that. DEUTZ looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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