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Today we'll evaluate H & M Hennes & Mauritz AB (publ) (STO:HM B) 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. 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 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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'.
How Do You Calculate Return On Capital Employed?
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 H & M Hennes & Mauritz:
0.20 = kr15b ÷ (kr122b - kr45b) (Based on the trailing twelve months to February 2019.)
Therefore, H & M Hennes & Mauritz has an ROCE of 20%.
Is H & M Hennes & Mauritz's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that H & M Hennes & Mauritz's ROCE is meaningfully better than the 11% average in the Specialty Retail 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. Setting aside the comparison to its industry for a moment, H & M Hennes & Mauritz's ROCE in absolute terms currently looks quite high.
H & M Hennes & Mauritz's current ROCE of 20% is lower than 3 years ago, when the company reported a 40% ROCE. Therefore we wonder if the company is facing new headwinds.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
H & M Hennes & Mauritz's Current Liabilities And Their Impact On Its 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.
H & M Hennes & Mauritz has total liabilities of kr45b and total assets of kr122b. Therefore its current liabilities are equivalent to approximately 37% of its total assets. H & M Hennes & Mauritz has a medium level of current liabilities, boosting its ROCE somewhat.
Our Take On H & M Hennes & Mauritz's ROCE
Still, it has a high ROCE, and may be an interesting prospect for further research. There might be better investments than H & M Hennes & Mauritz out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like H & M Hennes & Mauritz better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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.
If you spot an error that warrants correction, please contact the editor at email@example.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. Thank you for reading.