U.S. Markets closed

Is Bayerische Motoren Werke Aktiengesellschaft's (ETR:BMW) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we'll evaluate Bayerische Motoren Werke Aktiengesellschaft (ETR:BMW) 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. Last but not least, we'll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

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 Bayerische Motoren Werke:

0.047 = €6.8b ÷ (€227b - €81b) (Based on the trailing twelve months to September 2019.)

So, Bayerische Motoren Werke has an ROCE of 4.7%.

See our latest analysis for Bayerische Motoren Werke

Is Bayerische Motoren Werke's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Bayerische Motoren Werke's ROCE is around the 4.1% average reported by the Auto industry. Separate from how Bayerische Motoren Werke stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.

Bayerische Motoren Werke's current ROCE of 4.7% is lower than its ROCE in the past, which was 7.8%, 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Bayerische Motoren Werke's ROCE compares to its industry, and you can click it to see more detail on its past growth.

XTRA:BMW Past Revenue and Net Income, December 13th 2019

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Bayerische Motoren Werke.

Bayerische Motoren Werke's Current Liabilities And Their Impact On Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Bayerische Motoren Werke has total assets of €227b and current liabilities of €81b. Therefore its current liabilities are equivalent to approximately 36% of its total assets. Bayerische Motoren Werke's ROCE is improved somewhat by its moderate amount of current liabilities.

Our Take On Bayerische Motoren Werke's ROCE

Despite this, its ROCE is still mediocre, and you may find more appealing investments elsewhere. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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 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.

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. Thank you for reading.