Today we'll evaluate Lotus Bakeries NV (EBR:LOTB) to determine whether it could have potential as an investment idea. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of 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 metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. 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.
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 Lotus Bakeries:
0.16 = €98m ÷ (€799m - €193m) (Based on the trailing twelve months to June 2019.)
So, Lotus Bakeries has an ROCE of 16%.
Is Lotus Bakeries's ROCE Good?
One way to assess ROCE is to compare similar companies. Lotus Bakeries's ROCE appears to be substantially greater than the 7.3% average in the Food industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Lotus Bakeries 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 Lotus Bakeries's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
What Are Current Liabilities, And How Do They Affect Lotus Bakeries's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Lotus Bakeries has total liabilities of €193m and total assets of €799m. Therefore its current liabilities are equivalent to approximately 24% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Lotus Bakeries's ROCE
This is good to see, and with a sound ROCE, Lotus Bakeries could be worth a closer look. Lotus Bakeries 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.
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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.
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