Today we'll look at Kværner ASA (OB:KVAER) and reflect on its potential as an investment. 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. Then we'll compare its ROCE 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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 Kværner:
0.074 = kr296m ÷ (kr6.3b - kr2.3b) (Based on the trailing twelve months to September 2019.)
Therefore, Kværner has an ROCE of 7.4%.
Is Kværner's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. It appears that Kværner's ROCE is fairly close to the Energy Services industry average of 7.4%. Setting aside the industry comparison for now, Kværner's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.
We can see that, Kværner currently has an ROCE of 7.4%, less than the 16% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Kværner's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. We note Kværner could be considered a cyclical business. Since the future is so important for investors, you should check out our free report on analyst forecasts for Kværner.
What Are Current Liabilities, And How Do They Affect Kværner's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Kværner has total liabilities of kr2.3b and total assets of kr6.3b. As a result, its current liabilities are equal to approximately 36% of its total assets. Kværner's ROCE is improved somewhat by its moderate amount of current liabilities.
What We Can Learn From Kværner's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than Kværner. 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).
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.
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.