Today we’ll evaluate Koninklijke DSM N.V. (AMS:DSM) to determine whether it could have potential as an investment idea. In particular, we’ll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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 Koninklijke DSM:
0.11 = €1.2b ÷ (€14b – €2.6b) (Based on the trailing twelve months to December 2018.)
Therefore, Koninklijke DSM has an ROCE of 11%.
Does Koninklijke DSM Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Koninklijke DSM’s ROCE appears to be around the 13% average of the Chemicals industry. Regardless of where Koninklijke DSM sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Our data shows that Koninklijke DSM currently has an ROCE of 11%, compared to its ROCE of 3.8% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Koninklijke DSM.
Koninklijke DSM’s Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Koninklijke DSM has total assets of €14b and current liabilities of €2.6b. As a result, its current liabilities are equal to approximately 19% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Koninklijke DSM’s ROCE
Overall, Koninklijke DSM has a decent ROCE and could be worthy of further research. But note: Koninklijke DSM 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).
I will like Koninklijke DSM better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.