Examining Tikkurila Oyj’s (HEL:TIK1V) Weak Return On Capital Employed

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Today we are going to look at Tikkurila Oyj (HEL:TIK1V) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from 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. 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 Tikkurila Oyj:

0.074 = €21m ÷ (€537m - €304m) (Based on the trailing twelve months to June 2018.)

So, Tikkurila Oyj has an ROCE of 7.4%.

See our latest analysis for Tikkurila Oyj

Is Tikkurila Oyj's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, Tikkurila Oyj's ROCE appears to be significantly below the 11% average in the Chemicals industry. 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, Tikkurila Oyj's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Tikkurila Oyj's current ROCE of 7.4% is lower than 3 years ago, when the company reported a 23% ROCE. This makes us wonder if the business is facing new challenges.

It is important to remember that ROCE shows past performance, and is 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. 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 freereport on analyst forecasts for Tikkurila Oyj.

What Are Current Liabilities, And How Do They Affect Tikkurila Oyj's 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Tikkurila Oyj has total assets of €537m and current liabilities of €304m. As a result, its current liabilities are equal to approximately 57% of its total assets. Tikkurila Oyj has a fairly high level of current liabilities, meaningfully impacting its ROCE.

Our Take On Tikkurila Oyj's ROCE

Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. You might be able to find a better buy than Tikkurila Oyj. 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 like to buy stocks alongside management, then you might just love this freelist of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.