Why You Should Care About Tamedia AG’s (VTX:TAMN) Low Return On Capital

Today we'll evaluate Tamedia AG (VTX:TAMN) 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. 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. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'

So, How Do We Calculate ROCE?

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 Tamedia:

0.048 = CHF113m ÷ (CHF2.9b - CHF600m) (Based on the trailing twelve months to December 2018.)

Therefore, Tamedia has an ROCE of 4.8%.

View our latest analysis for Tamedia

Is Tamedia's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Tamedia's ROCE is meaningfully below the Media industry average of 9.8%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Tamedia compares to its industry, its ROCE in absolute terms is low; especially compared to the ~3.3% available in government bonds. Readers may wish to look for more rewarding investments.

Tamedia's current ROCE of 4.8% is lower than its ROCE in the past, which was 7.7%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our freereport on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Tamedia's 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.

Tamedia has total assets of CHF2.9b and current liabilities of CHF600m. Therefore its current liabilities are equivalent to approximately 20% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

Our Take On Tamedia's ROCE

That's not a bad thing, however Tamedia has a weak ROCE and may not be an attractive investment. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this freelist of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this freelist of companies. (Hint: insiders have been buying them).

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.