Atlas Copco AB (STO:ATCO A) Is Employing Capital Very Effectively

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Today we'll look at Atlas Copco AB (STO:ATCO A) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.'

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 Atlas Copco:

0.30 = kr21b ÷ (kr102b - kr32b) (Based on the trailing twelve months to March 2019.)

So, Atlas Copco has an ROCE of 30%.

See our latest analysis for Atlas Copco

Does Atlas Copco Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Atlas Copco's ROCE is meaningfully better than the 15% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Putting aside its position relative to its industry for now, in absolute terms, Atlas Copco's ROCE is currently very good.

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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Atlas Copco.

What Are Current Liabilities, And How Do They Affect Atlas Copco'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.

Atlas Copco has total assets of kr102b and current liabilities of kr32b. Therefore its current liabilities are equivalent to approximately 31% of its total assets. Atlas Copco's ROCE is boosted somewhat by its middling amount of current liabilities.

The Bottom Line On Atlas Copco's ROCE

Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than Atlas Copco 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.

I will like Atlas Copco 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 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.