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Today we’ll evaluate AUDI AG (FRA:NSU) 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.
Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the 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?
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 AUDI:
0.13 = €5.5b ÷ (€67b – €24b) (Based on the trailing twelve months to June 2018.)
So, AUDI has an ROCE of 13%.
Is AUDI’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, we find that AUDI’s ROCE is meaningfully better than the 6.4% average in the Auto industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where AUDI sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
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. If AUDI is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How AUDI’s Current Liabilities Impact Its ROCE
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
AUDI has total assets of €67b and current liabilities of €24b. As a result, its current liabilities are equal to approximately 36% of its total assets. AUDI has a medium level of current liabilities, which would boost the ROCE.
The Bottom Line On AUDI’s ROCE
AUDI’s ROCE does look good, but the level of current liabilities also contribute to that. You might be able to find a better buy than AUDI. 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).
I will like AUDI better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.