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Today we are going to look at Hexagon AB (publ) (STO:HEXA B) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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. 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?
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 Hexagon:
0.11 = €951m ÷ (€10b - €1.6b) (Based on the trailing twelve months to March 2019.)
Therefore, Hexagon has an ROCE of 11%.
Is Hexagon's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Hexagon's ROCE is around the 14% average reported by the Electronic industry. Regardless of where Hexagon sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can click on the image below to see (in greater detail) how Hexagon'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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Hexagon.
Hexagon's Current Liabilities And Their Impact On Its ROCE
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Hexagon has total liabilities of €1.6b and total assets of €10b. As a result, its current liabilities are equal to approximately 16% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From Hexagon's ROCE
This is good to see, and with a sound ROCE, Hexagon could be worth a closer look. Hexagon looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are 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.