Why We’re Not Impressed By ElringKlinger AG’s (FRA:ZIL2) 4.4% ROCE

Today we’ll look at ElringKlinger AG (FRA:ZIL2) and reflect on its potential as an investment. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Last but not least, we’ll look at what impact its current liabilities have on 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.’

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 ElringKlinger:

0.044 = €67m ÷ (€2.1b – €547m) (Based on the trailing twelve months to December 2018.)

Therefore, ElringKlinger has an ROCE of 4.4%.

See our latest analysis for ElringKlinger

Does ElringKlinger Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, ElringKlinger’s ROCE appears meaningfully below the 9.9% average reported by the Auto Components industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, ElringKlinger’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

As we can see, ElringKlinger currently has an ROCE of 4.4%, less than the 9.6% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

DB:ZIL2 Past Revenue and Net Income, April 12th 2019
DB:ZIL2 Past Revenue and Net Income, April 12th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for ElringKlinger.

Do ElringKlinger’s Current Liabilities Skew Its ROCE?

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

ElringKlinger has total liabilities of €547m and total assets of €2.1b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

What We Can Learn From ElringKlinger’s ROCE

That said, ElringKlinger’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than ElringKlinger. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like ElringKlinger better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.