Today we’ll evaluate Arkema S.A. (EPA:AKE) to determine whether it could have potential as an investment idea. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First up, we’ll look at what ROCE is and how we calculate it. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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 Arkema:
0.12 = €886m ÷ (€10b – €1.7b) (Based on the trailing twelve months to September 2018.)
So, Arkema has an ROCE of 12%.
Is Arkema’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Arkema’s ROCE is meaningfully better than the 9.4% average in the Chemicals 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. Separate from Arkema’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, Arkema’s ROCE appears to be 12%, compared to 3 years ago, when its ROCE was 9.0%. This makes us wonder if the company is improving.
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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Arkema.
Arkema’s Current Liabilities And Their Impact On Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Arkema has total assets of €10b and current liabilities of €1.7b. As a result, its current liabilities are equal to approximately 17% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Arkema’s ROCE
This is good to see, and with a sound ROCE, Arkema could be worth a closer look. You might be able to find a better buy than Arkema. 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).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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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.