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Today we’ll evaluate Progress-Werk Oberkirch AG (FRA:PWO) 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.
First, we’ll go over how we calculate ROCE. 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.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Progress-Werk Oberkirch:
0.062 = €17m ÷ (€424m – €158m) (Based on the trailing twelve months to March 2019.)
Therefore, Progress-Werk Oberkirch has an ROCE of 6.2%.
Is Progress-Werk Oberkirch’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Progress-Werk Oberkirch’s ROCE is meaningfully below the Auto Components industry average of 9.1%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Progress-Werk Oberkirch’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Progress-Werk Oberkirch.
How Progress-Werk Oberkirch’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Progress-Werk Oberkirch has total liabilities of €158m and total assets of €424m. As a result, its current liabilities are equal to approximately 37% of its total assets. Progress-Werk Oberkirch’s middling level of current liabilities have the effect of boosting its ROCE a bit.
Our Take On Progress-Werk Oberkirch’s ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might also be able to find a better stock than Progress-Werk Oberkirch. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 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. Thank you for reading.