Newag S.A.’s (WSE:NWG) Investment Returns Are Lagging Its Industry

Today we’ll look at Newag S.A. (WSE:NWG) and reflect on its potential as an investment. 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. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’

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 Newag:

0.12 = zł46m ÷ (zł1.1b – zł510m) (Based on the trailing twelve months to September 2018.)

Therefore, Newag has an ROCE of 12%.

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Is Newag’s ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that Newag’s ROCE is meaningfully better than the 8.7% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Independently of how Newag compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

As we can see, Newag currently has an ROCE of 12% compared to its ROCE 3 years ago, which was 5.8%. This makes us wonder if the company is improving.

WSE:NWG Last Perf January 22nd 19
WSE:NWG Last Perf January 22nd 19

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Newag’s Current Liabilities And Their Impact On Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Newag has total liabilities of zł510m and total assets of zł1.1b. Therefore its current liabilities are equivalent to approximately 47% of its total assets. With this level of current liabilities, Newag’s ROCE is boosted somewhat.

The Bottom Line On Newag’s ROCE

With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Of course you might be able to find a better stock than Newag. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.