Today we’ll look at Rheinmetall AG (ETR:RHM) 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.
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 amount of pre-tax profits a company can generate from the capital employed 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.
So, How Do We Calculate ROCE?
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 Rheinmetall:
0.11 = €474m ÷ (€7.1b – €2.9b) (Based on the trailing twelve months to September 2019.)
So, Rheinmetall has an ROCE of 11%.
Does Rheinmetall Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Rheinmetall’s ROCE is meaningfully better than the 5.4% average in the Industrials industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Rheinmetall’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
Our data shows that Rheinmetall currently has an ROCE of 11%, compared to its ROCE of 8.5% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly. You can see in the image below how Rheinmetall’s ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. 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 Rheinmetall.
What Are Current Liabilities, And How Do They Affect Rheinmetall’s 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Rheinmetall has current liabilities of €2.9b and total assets of €7.1b. Therefore its current liabilities are equivalent to approximately 40% of its total assets. Rheinmetall has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On Rheinmetall’s ROCE
Rheinmetall’s ROCE does look good, but the level of current liabilities also contribute to that. Rheinmetall shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 email@example.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.
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