Today we'll look at Linz Textil Holding Aktiengesellschaft (VIE:LTH) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. All else being equal, a better business will have a higher ROCE. 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'.
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 Linz Textil Holding:
0.024 = €2.1m ÷ (€101m - €11m) (Based on the trailing twelve months to June 2019.)
Therefore, Linz Textil Holding has an ROCE of 2.4%.
Does Linz Textil Holding Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, Linz Textil Holding's ROCE appears to be significantly below the 8.4% average in the Luxury industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how Linz Textil Holding compares to its industry, its ROCE in absolute terms is low; especially compared to the ~0.5% available in government bonds. It is likely that there are more attractive prospects out there.
Linz Textil Holding's current ROCE of 2.4% is lower than its ROCE in the past, which was 6.0%, 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how Linz Textil Holding's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. How cyclical is Linz Textil Holding? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Do Linz Textil Holding'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 ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Linz Textil Holding has total assets of €101m and current liabilities of €11m. Therefore its current liabilities are equivalent to approximately 11% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.
What We Can Learn From Linz Textil Holding's ROCE
While that is good to see, Linz Textil Holding has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Linz Textil Holding. 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.