Today we’ll look at Indra Sistemas, S.A. (BME:IDR) 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.
First of all, we’ll work out how to calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 Indra Sistemas:
0.087 = €197m ÷ (€4.0b – €1.8b) (Based on the trailing twelve months to September 2018.)
So, Indra Sistemas has an ROCE of 8.7%.
Is Indra Sistemas’s ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, Indra Sistemas’s ROCE appears to be around the 9.1% average of the IT industry. Setting aside the industry comparison for now, Indra Sistemas’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
Indra Sistemas delivered an ROCE of 8.7%, which is better than 3 years ago, as was making losses back then. That implies the business has been improving.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Indra Sistemas.
What Are Current Liabilities, And How Do They Affect Indra Sistemas’s 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Indra Sistemas has total liabilities of €1.8b and total assets of €4.0b. Therefore its current liabilities are equivalent to approximately 46% of its total assets. Indra Sistemas’s middling level of current liabilities have the effect of boosting its ROCE a bit.
The Bottom Line On Indra Sistemas’s ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: Indra Sistemas may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.