Today we'll evaluate NCC AB (publ) (STO:NCC B) to determine whether it could have potential as an investment idea. 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. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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?
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 NCC:
0.10 = kr1.3b ÷ (kr30b - kr17b) (Based on the trailing twelve months to December 2019.)
Therefore, NCC has an ROCE of 10%.
Does NCC Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, NCC's ROCE appears to be significantly below the 14% average in the Construction industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Regardless of where NCC sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
NCC's current ROCE of 10% is lower than 3 years ago, when the company reported a 14% ROCE. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how NCC's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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.
What Are Current Liabilities, And How Do They Affect NCC's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
NCC has total assets of kr30b and current liabilities of kr17b. Therefore its current liabilities are equivalent to approximately 58% of its total assets. This is admittedly a high level of current liabilities, improving ROCE substantially.
What We Can Learn From NCC's ROCE
The ROCE would not look as appealing if the company had fewer current liabilities. There might be better investments than NCC 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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