Today we'll evaluate InnoTec TSS AG (FRA:TSS) 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. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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?
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 InnoTec TSS:
0.12 = €11m ÷ (€105m - €12m) (Based on the trailing twelve months to June 2019.)
Therefore, InnoTec TSS has an ROCE of 12%.
Does InnoTec TSS Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that InnoTec TSS's ROCE is meaningfully better than the 7.0% average in the Building 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. Regardless of where InnoTec TSS sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, InnoTec TSS currently has an ROCE of 12%, less than the 21% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how InnoTec TSS's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. 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 only a point-in-time measure. How cyclical is InnoTec TSS? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do InnoTec TSS's Current Liabilities Skew Its 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.
InnoTec TSS has current liabilities of €12m and total assets of €105m. As a result, its current liabilities are equal to approximately 12% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
What We Can Learn From InnoTec TSS's ROCE
With that in mind, InnoTec TSS's ROCE appears pretty good. InnoTec TSS 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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