Here’s why Softing AG’s (ETR:SYT) Returns On Capital Matters So Much

Today we’ll evaluate Softing AG (ETR:SYT) to determine whether it could have potential as an investment idea. 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. 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.

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. Ultimately, it is a useful but imperfect metric. 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 Softing:

0.048 = €4.6m ÷ (€113m – €18m) (Based on the trailing twelve months to September 2019.)

Therefore, Softing has an ROCE of 4.8%.

Check out our latest analysis for Softing

Does Softing Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Softing’s ROCE appears to be significantly below the 11% average in the Electronic industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Separate from how Softing 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.

We can see that, Softing currently has an ROCE of 4.8%, less than the 7.7% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Softing’s ROCE compares to its industry, and you can click it to see more detail on its past growth.

XTRA:SYT Past Revenue and Net Income, February 12th 2020
XTRA:SYT Past Revenue and Net Income, February 12th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Softing.

How Softing’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 counter this, investors can check if a company has high current liabilities relative to total assets.

Softing has total assets of €113m and current liabilities of €18m. Therefore its current liabilities are equivalent to approximately 16% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.

What We Can Learn From Softing’s ROCE

With that in mind, we’re not overly impressed with Softing’s ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Softing. 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).

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.