Why We Like Wagners Holding Company Limited’s (ASX:WGN) 23% Return On Capital Employed

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Today we'll evaluate Wagners Holding Company Limited (ASX:WGN) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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?

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 Wagners Holding:

0.23 = AU$31m ÷ (AU$190m - AU$54m) (Based on the trailing twelve months to December 2018.)

So, Wagners Holding has an ROCE of 23%.

View our latest analysis for Wagners Holding

Is Wagners Holding's ROCE Good?

One way to assess ROCE is to compare similar companies. Using our data, we find that Wagners Holding's ROCE is meaningfully better than the 11% average in the Basic Materials industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Wagners Holding's ROCE in absolute terms currently looks quite high.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Wagners Holding.

Do Wagners Holding's Current Liabilities Skew 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Wagners Holding has total liabilities of AU$54m and total assets of AU$190m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

Our Take On Wagners Holding's ROCE

Low current liabilities and high ROCE is a good combination, making Wagners Holding look quite interesting. There might be better investments than Wagners Holding 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.

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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.

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. Thank you for reading.