Today we are going to look at Fjord1 ASA (OB:FJORD) to see whether it might be an attractive investment prospect. 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.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. Generally speaking a higher ROCE is better. In brief, ROCE 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'.
So, How Do We Calculate ROCE?
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 Fjord1:
0.15 = øre708m ÷ (øre6.0b - øre1.1b) (Based on the trailing twelve months to September 2018.)
Therefore, Fjord1 has an ROCE of 15%.
Does Fjord1 Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, Fjord1's ROCE is meaningfully higher than the 5.7% average in the Shipping industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Fjord1's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Fjord1 currently has an ROCE of 15% compared to its ROCE 3 years ago, which was 7.2%. This makes us think about whether the company has been reinvesting shrewdly.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our freereport on analyst forecasts for Fjord1.
What Are Current Liabilities, And How Do They Affect Fjord1'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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Fjord1 has total liabilities of øre1.1b and total assets of øre6.0b. As a result, its current liabilities are equal to approximately 19% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Fjord1's ROCE
With that in mind, Fjord1's ROCE appears pretty good. The ROCE can give us an idea of the quality of a business, but we need to look deeper if we are considering a purchase. For example you might check if insiders are buying shares.
Of course Fjord1 may not be the best stock to buy. So you may wish to see this free collection of other companies that have 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.