Today we are going to look at Adler Modemärkte AG (ETR:ADD) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Adler Modemärkte:
0.091 = €27m ÷ (€409m – €108m) (Based on the trailing twelve months to December 2019.)
Therefore, Adler Modemärkte has an ROCE of 9.1%.
Is Adler Modemärkte’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Adler Modemärkte’s ROCE appears to be around the 7.8% average of the Specialty Retail industry. Separate from Adler Modemärkte’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
In our analysis, Adler Modemärkte’s ROCE appears to be 9.1%, compared to 3 years ago, when its ROCE was 2.8%. This makes us think the business might be improving. The image below shows how Adler Modemärkte’s ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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 Adler Modemärkte.
How Adler Modemärkte’s Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Adler Modemärkte has total assets of €409m and current liabilities of €108m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Adler Modemärkte’s ROCE
With that in mind, Adler Modemärkte’s ROCE appears pretty good. There might be better investments than Adler Modemärkte out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
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.
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