Today we are going to look at Renk Aktiengesellschaft (FRA:ZAR) to see whether it might be an attractive investment prospect. 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. 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 measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 Renk:
0.11 = €60m ÷ (€753m – €197m) (Based on the trailing twelve months to December 2018.)
So, Renk has an ROCE of 11%.
Is Renk’s ROCE Good?
One way to assess ROCE is to compare similar companies. It appears that Renk’s ROCE is fairly close to the Auto Components industry average of 9.8%. Independently of how Renk compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Renk’s current ROCE of 11% is lower than its ROCE in the past, which was 15%, 3 years ago. So investors might consider if it has had issues recently.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. How cyclical is Renk? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Renk’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Renk has total assets of €753m and current liabilities of €197m. As a result, its current liabilities are equal to approximately 26% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Renk’s ROCE
Overall, Renk has a decent ROCE and could be worthy of further research. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
I will like Renk better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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