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Today we are going to look at Lechwerke AG (FRA:LEC) 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 of all, we’ll work out how to calculate ROCE. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Lechwerke:
0.12 = €68m ÷ (€1.8b – €1.3b) (Based on the trailing twelve months to December 2018.)
So, Lechwerke has an ROCE of 12%.
Is Lechwerke’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Lechwerke’s ROCE is meaningfully higher than the 7.6% average in the Electric Utilities industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Lechwerke sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Remember that this metric is backwards looking – it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. If Lechwerke is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Lechwerke’s Current Liabilities Impact Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Lechwerke has total liabilities of €1.3b and total assets of €1.8b. As a result, its current liabilities are equal to approximately 68% of its total assets. Lechwerke’s current liabilities are fairly high, which increases its ROCE significantly.
Our Take On Lechwerke’s ROCE
While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. Lechwerke 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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 email@example.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.