Today we'll look at Amadeus IT Group, S.A. (BME:AMS) 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. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. 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 Amadeus IT Group:
0.19 = €1.4b ÷ (€10b - €2.7b) (Based on the trailing twelve months to December 2018.)
So, Amadeus IT Group has an ROCE of 19%.
Does Amadeus IT Group Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Amadeus IT Group's ROCE appears to be substantially greater than the 11% average in the IT industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Amadeus IT Group compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Amadeus IT Group's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Amadeus IT Group has total assets of €10b and current liabilities of €2.7b. As a result, its current liabilities are equal to approximately 27% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Amadeus IT Group's ROCE
With that in mind, Amadeus IT Group's ROCE appears pretty good. Amadeus IT Group 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.
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