Why We’re Not Keen On SHW AG’s (FRA:SW1) 9.4% Return On Capital

Today we’ll look at SHW AG (FRA:SW1) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First of all, we’ll work out how to calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

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

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. In brief, ROCE 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 SHW:

0.094 = €18m ÷ (€278m – €114m) (Based on the trailing twelve months to June 2018.)

Therefore, SHW has an ROCE of 9.4%.

See our latest analysis for SHW

Does SHW Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see SHW’s ROCE is around the 9.4% average reported by the Auto Components industry. Separate from SHW’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

SHW’s current ROCE of 9.4% is lower than 3 years ago, when the company reported a 15% ROCE. This makes us wonder if the business is facing new challenges.

DB:SW1 Last Perf December 12th 18
DB:SW1 Last Perf December 12th 18

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. You can see analyst predictions in our free report on analyst forecasts for the company.

Do SHW’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 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) unfairly boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

SHW has total liabilities of €114m and total assets of €278m. As a result, its current liabilities are equal to approximately 41% of its total assets.

Our Take On SHW’s ROCE

SHW has a middling amount of current liabilities, increasing its ROCE somewhat. With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. You might be able to find a better buy than SHW. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you would prefer check out another company — one with potentially superior financials — then do not miss this free list of interesting companies, that have HIGH return on equity and low debt.

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.