Today we are going to look at Vereinigte Filzfabriken AG (MUN:VFF) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect 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. Ultimately, it is a useful but imperfect metric. 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 Vereinigte Filzfabriken:
0.13 = €708k ÷ (€9.6m - €4.4m) (Based on the trailing twelve months to June 2018.)
So, Vereinigte Filzfabriken has an ROCE of 13%.
Does Vereinigte Filzfabriken Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Vereinigte Filzfabriken's ROCE is around the 15% average reported by the Luxury industry. Regardless of where Vereinigte Filzfabriken sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
As we can see, Vereinigte Filzfabriken currently has an ROCE of 13%, less than the 29% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is Vereinigte Filzfabriken? You can see for yourself by looking at this freegraph of past earnings, revenue and cash flow.
Vereinigte Filzfabriken's Current Liabilities And Their Impact On 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. 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Vereinigte Filzfabriken has total assets of €9.6m and current liabilities of €4.4m. As a result, its current liabilities are equal to approximately 45% of its total assets. With this level of current liabilities, Vereinigte Filzfabriken's ROCE is boosted somewhat.
The Bottom Line On Vereinigte Filzfabriken's ROCE
Vereinigte Filzfabriken's ROCE does look good, but the level of current liabilities also contribute to that. You might be able to find a better buy than Vereinigte Filzfabriken. If you want a selection of possible winners, check out this freelist of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you are like me, then you will not want to miss this freelist of growing companies that insiders are buying.
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