Today we’ll look at Rapala VMC Corporation (HEL:RAP1V) and reflect on its potential as an investment. 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. 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. 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?
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 Rapala VMC:
0.086 = €11m ÷ (€287m – €113m) (Based on the trailing twelve months to June 2018.)
So, Rapala VMC has an ROCE of 8.6%.
Does Rapala VMC Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Rapala VMC’s ROCE is meaningfully below the Leisure industry average of 12%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Setting aside the industry comparison for now, Rapala VMC’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. You can see analyst predictions in our free report on analyst forecasts for the company.
Do Rapala VMC’s Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Rapala VMC has total assets of €287m and current liabilities of €113m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. Rapala VMC’s middling level of current liabilities have the effect of boosting its ROCE a bit.
What We Can Learn From Rapala VMC’s ROCE
Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course you might be able to find a better stock than Rapala VMC. So you may wish to see this free collection of other companies that have grown earnings strongly.
But note: Rapala VMC may not be the best stock to buy. So take a peek at this free list of interesting companies with high ROE and low debt.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.