Today we'll evaluate Novozymes A/S (CPH:NZYM B) to determine whether it could have potential as an investment idea. 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.
Firstly, we'll go over how we 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 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. 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?
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 Novozymes:
0.23 = ø3.6b ÷ (ø20b - ø4.7b) (Based on the trailing twelve months to December 2019.)
So, Novozymes has an ROCE of 23%.
See our latest analysis for Novozymes
Does Novozymes Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Novozymes's ROCE is meaningfully better than the 9.0% average in the Chemicals industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Regardless of the industry comparison, in absolute terms, Novozymes's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how Novozymes's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Novozymes.
How Novozymes's Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Novozymes has current liabilities of ø4.7b and total assets of ø20b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
Our Take On Novozymes's ROCE
Low current liabilities and high ROCE is a good combination, making Novozymes look quite interesting. Novozymes 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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