Is Palfinger AG (VIE:PAL) Investing Effectively In Its Business?

Today we are going to look at Palfinger AG (VIE:PAL) 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 up, we'll look at what ROCE is and how we calculate it. 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.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 Palfinger:

0.10 = €101m ÷ (€1.6b - €504m) (Based on the trailing twelve months to September 2018.)

So, Palfinger has an ROCE of 10%.

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Is Palfinger's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see Palfinger's ROCE is around the 11% average reported by the Machinery industry. Separate from Palfinger'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, Palfinger's ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 7.9%. This makes us think the business might be improving.

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 freereport on analyst forecasts for Palfinger.

How Palfinger'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.

Palfinger has total liabilities of €504m and total assets of €1.6b. Therefore its current liabilities are equivalent to approximately 32% of its total assets. Palfinger has a middling amount of current liabilities, increasing its ROCE somewhat.

Our Take On Palfinger's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Of course you might be able to find a better stock than Palfinger. So you may wish to see this freecollection of other companies that have grown earnings strongly.

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

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.