Here’s why HORNBACH Baumarkt AG’s (FRA:HBM) Returns On Capital Matters So Much

Today we are going to look at HORNBACH Baumarkt AG (FRA:HBM) to see whether it might be an attractive investment prospect. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, 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.

Return On Capital Employed (ROCE): What is it?

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 HORNBACH Baumarkt:

0.038 = €102m ÷ (€3.6b – €917m) (Based on the trailing twelve months to May 2019.)

Therefore, HORNBACH Baumarkt has an ROCE of 3.8%.

Check out our latest analysis for HORNBACH Baumarkt

Does HORNBACH Baumarkt Have A Good ROCE?

One way to assess ROCE is to compare similar companies. In this analysis, HORNBACH Baumarkt’s ROCE appears meaningfully below the 5.5% average reported by the Specialty Retail industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, HORNBACH Baumarkt’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.

HORNBACH Baumarkt’s current ROCE of 3.8% is lower than 3 years ago, when the company reported a 6.4% ROCE. So investors might consider if it has had issues recently.

DB:HBM Past Revenue and Net Income, August 14th 2019
DB:HBM Past Revenue and Net Income, August 14th 2019

When considering this metric, keep in mind that it is backwards looking, and 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 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.

HORNBACH Baumarkt’s Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

HORNBACH Baumarkt has total liabilities of €917m and total assets of €3.6b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.

The Bottom Line On HORNBACH Baumarkt’s ROCE

If HORNBACH Baumarkt continues to earn an uninspiring ROCE, there may be better places to invest. 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.