Today we’ll evaluate Solteq Oyj (HEL:SOLTEQ) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we’ll work out how to calculate ROCE. Next, we’ll compare it to others in its industry. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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?
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 Solteq Oyj:
0.11 = €3.1m ÷ (€72m – €43m) (Based on the trailing twelve months to September 2019.)
Therefore, Solteq Oyj has an ROCE of 11%.
Is Solteq Oyj’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Solteq Oyj’s ROCE is meaningfully better than the 7.4% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Solteq Oyj compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Solteq Oyj currently has an ROCE of 11% compared to its ROCE 3 years ago, which was 3.7%. This makes us wonder if the company is improving. The image below shows how Solteq Oyj’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Solteq Oyj.
Solteq Oyj’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.
Solteq Oyj has current liabilities of €43m and total assets of €72m. As a result, its current liabilities are equal to approximately 59% of its total assets. Solteq Oyj has a relatively high level of current liabilities, boosting its ROCE meaningfully.
The Bottom Line On Solteq Oyj’s ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. Solteq Oyj 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.
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 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.
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.