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Today we’ll evaluate Recticel NV/SA (EBR:REC) to determine whether it could have potential as an investment idea. 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.

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

ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Recticel/SA:

0.15 = €54m ÷ (€776m – €401m) (Based on the trailing twelve months to June 2018.)

Therefore, Recticel/SA has an ROCE of 15%.

See our latest analysis for Recticel/SA

Does Recticel/SA Have A Good ROCE?

One way to assess ROCE is to compare similar companies. Recticel/SA’s ROCE appears to be substantially greater than the 9.9% average in the Chemicals industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from Recticel/SA’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

In our analysis, Recticel/SA’s ROCE appears to be 15%, compared to 3 years ago, when its ROCE was 4.1%. This makes us think the business might be improving.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Recticel/SA’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Recticel/SA has total assets of €776m and current liabilities of €401m. Therefore its current liabilities are equivalent to approximately 52% of its total assets. Recticel/SA’s current liabilities are fairly high, which increases its ROCE significantly.

What We Can Learn From Recticel/SA’s ROCE

While its ROCE looks decent, it wouldn’t look so good if it reduced current liabilities. You might be able to find a better buy than Recticel/SA. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.