Today we are going to look at Renk Aktiengesellschaft (FRA:ZAR) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed 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.’
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 Renk:
0.11 = €61m ÷ (€753m – €197m) (Based on the trailing twelve months to December 2018.)
So, Renk has an ROCE of 11%.
Is Renk’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Renk’s ROCE is around the 9.1% average reported by the Auto Components industry. 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.
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 only a point-in-time measure. How cyclical is Renk? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Renk’s 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 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.
What We Can Learn From Renk’s ROCE
With that in mind, Renk’s ROCE appears pretty good. Renk looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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