Should You Like Newag S.A.’s (WSE:NWG) High Return On Capital Employed?

Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today we’ll look at Newag S.A. (WSE:NWG) 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.

Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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’.

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:

0.18 = zł126m ÷ (zł1.2b – zł500m) (Based on the trailing twelve months to March 2019.)

Therefore, Newag has an ROCE of 18%.

Check out our latest analysis for Newag

Does Newag Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Newag’s ROCE appears to be substantially greater than the 8.6% average in the Machinery 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 Newag’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, Newag currently has an ROCE of 18% compared to its ROCE 3 years ago, which was 12%. This makes us think the business might be improving.

WSE:NWG Past Revenue and Net Income, June 17th 2019
WSE:NWG Past Revenue and Net Income, June 17th 2019

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 Newag.

How Newag’s Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.

Newag has total assets of zł1.2b and current liabilities of zł500m. Therefore its current liabilities are equivalent to approximately 41% of its total assets. With this level of current liabilities, Newag’s ROCE is boosted somewhat.

The Bottom Line On Newag’s ROCE

While its ROCE looks good, it’s worth remembering that the current liabilities are making the business look better. There might be better investments than Newag out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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