Don’t Buy Klingelnberg AG (VTX:KLIN) Until You Understand Its ROCE

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Today we'll look at Klingelnberg AG (VTX:KLIN) and reflect on its potential as an investment. 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. 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'.

So, How Do We Calculate ROCE?

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 Klingelnberg:

0.14 = €23m ÷ (€240m - €78m) (Based on the trailing twelve months to September 2018.)

Therefore, Klingelnberg has an ROCE of 14%.

See our latest analysis for Klingelnberg

Does Klingelnberg Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Klingelnberg's ROCE is around the 14% average reported by the Machinery industry. Separate from Klingelnberg's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our freereport on analyst forecasts for the company.

How Klingelnberg's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Klingelnberg has total assets of €240m and current liabilities of €78m. Therefore its current liabilities are equivalent to approximately 33% of its total assets. Klingelnberg has a middling amount of current liabilities, increasing its ROCE somewhat.

Our Take On Klingelnberg's ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Klingelnberg 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 are like me, then you will not want to miss this freelist of growing companies that insiders are buying.

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.