Today we'll evaluate Trelleborg AB (publ) (STO:TREL B) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

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. 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?

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 Trelleborg:

0.10 = kr4.5b ÷ (kr58b - kr13b) (Based on the trailing twelve months to March 2019.)

Therefore, Trelleborg has an ROCE of 10%.

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Is Trelleborg's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. In this analysis, Trelleborg's ROCE appears meaningfully below the 15% average reported by the Machinery industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from Trelleborg's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

When considering this metric, keep in mind that it is backwards looking, and 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do Trelleborg's Current Liabilities Skew Its 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Trelleborg has total liabilities of kr13b and total assets of kr58b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.

Our Take On Trelleborg's ROCE

This is good to see, and with a sound ROCE, Trelleborg could be worth a closer look. There might be better investments than Trelleborg 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.

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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.