Today we are going to look at Addtech AB (publ.) (STO:ADDT B) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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'.
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 Addtech AB (publ.):
0.22 = kr1.1b ÷ (kr8.1b - kr3.4b) (Based on the trailing twelve months to September 2019.)
So, Addtech AB (publ.) has an ROCE of 22%.
Does Addtech AB (publ.) Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Addtech AB (publ.)'s ROCE appears to be substantially greater than the 13% average in the Trade Distributors industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of the industry comparison, in absolute terms, Addtech AB (publ.)'s ROCE currently appears to be excellent.
The image below shows how Addtech AB (publ.)'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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. 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 Addtech AB (publ.)'s ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Addtech AB (publ.) has current liabilities of kr3.4b and total assets of kr8.1b. Therefore its current liabilities are equivalent to approximately 42% of its total assets. A medium level of current liabilities boosts Addtech AB (publ.)'s ROCE somewhat.
Our Take On Addtech AB (publ.)'s ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. Addtech AB (publ.) shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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