Should Ansaldo STS S.p.A.’s (BIT:STS) Weak Investment Returns Worry You?

Today we’ll evaluate Ansaldo STS S.p.A. (BIT:STS) 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.

First of all, we’ll work out how to 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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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’.

So, How Do We Calculate ROCE?

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 Ansaldo STS:

0.12 = €104m ÷ (€2.0b – €1.2b) (Based on the trailing twelve months to September 2018.)

Therefore, Ansaldo STS has an ROCE of 12%.

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Is Ansaldo STS’s ROCE Good?

One way to assess ROCE is to compare similar companies. Ansaldo STS’s ROCE appears to be substantially greater than the 9.7% average in the Infrastructure industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from Ansaldo STS’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

Ansaldo STS’s current ROCE of 12% is lower than its ROCE in the past, which was 22%, 3 years ago. Therefore we wonder if the company is facing new headwinds.

BIT:STS Last Perf January 11th 19
BIT:STS Last Perf January 11th 19

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Ansaldo STS.

Ansaldo STS’s Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Ansaldo STS has total liabilities of €1.2b and total assets of €2.0b. As a result, its current liabilities are equal to approximately 60% of its total assets. Ansaldo STS has a relatively high level of current liabilities, boosting its ROCE meaningfully.

What We Can Learn From Ansaldo STS’s ROCE

This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. But note: Ansaldo STS may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.