Should You Like MKB Nedsense NV’s (AMS:NEDSE) High Return On Capital Employed?

Today we'll look at MKB Nedsense NV (AMS:NEDSE) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting 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. 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?

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 MKB Nedsense:

0.18 = €1.3m ÷ (€7.3m - €132k) (Based on the trailing twelve months to June 2019.)

Therefore, MKB Nedsense has an ROCE of 18%.

See our latest analysis for MKB Nedsense

Does MKB Nedsense Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that MKB Nedsense's ROCE is meaningfully better than the 11% average in the Software industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Separate from MKB Nedsense's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

MKB Nedsense reported an ROCE of 18% -- better than 3 years ago, when the company didn't make a profit. That implies the business has been improving. Take a look at the image below to see how MKB Nedsense's past growth compares to the average in its industry.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is MKB Nedsense? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect MKB Nedsense's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. 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.

MKB Nedsense has total assets of €7.3m and current liabilities of €132k. As a result, its current liabilities are equal to approximately 1.8% of its total assets. Low current liabilities have only a minimal impact on MKB Nedsense's ROCE, making its decent returns more credible.

The Bottom Line On MKB Nedsense's ROCE

If it is able to keep this up, MKB Nedsense could be attractive. MKB Nedsense looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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 editorial-team@simplywallst.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.