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Today we’ll evaluate Componenta Corporation (HEL:CTH1V) to determine whether it could have potential as an investment idea. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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?
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 Componenta:
0.045 = €1.6m ÷ (€49m – €13m) (Based on the trailing twelve months to December 2018.)
Therefore, Componenta has an ROCE of 4.5%.
Does Componenta Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Componenta’s ROCE is meaningfully below the Machinery industry average of 13%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from how Componenta stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
Componenta has an ROCE of 4.5%, but it didn’t have an ROCE 3 years ago, since it was unprofitable. That implies the business has been improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If Componenta is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Componenta’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Componenta has total liabilities of €13m and total assets of €49m. As a result, its current liabilities are equal to approximately 27% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
The Bottom Line On Componenta’s ROCE
That said, Componenta’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Componenta. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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 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.