Today we are going to look at Delignit AG (ETR:DLX) 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.
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 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. Overall, it is a valuable metric that has its flaws. 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'.
How Do You Calculate Return On Capital Employed?
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 Delignit:
0.10 = €3.1m ÷ (€45m - €14m) (Based on the trailing twelve months to June 2019.)
Therefore, Delignit has an ROCE of 10%.
Is Delignit's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Delignit's ROCE is around the 8.7% average reported by the Forestry industry. Regardless of where Delignit sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
In our analysis, Delignit's ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 6.0%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Delignit's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Delignit.
How Delignit's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Delignit has total liabilities of €14m and total assets of €45m. Therefore its current liabilities are equivalent to approximately 32% of its total assets. With this level of current liabilities, Delignit's ROCE is boosted somewhat.
Our Take On Delignit's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Delignit looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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If you spot an error that warrants correction, please contact the editor at email@example.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.