Today we’ll look at Nokian Renkaat Oyj (HEL:NRE1V) and reflect on its potential as an investment. 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 up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. And finally, we’ll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
So, How Do We Calculate ROCE?
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 Nokian Renkaat Oyj:
0.26 = €366m ÷ (€2.0b – €557m) (Based on the trailing twelve months to September 2018.)
Therefore, Nokian Renkaat Oyj has an ROCE of 26%.
Is Nokian Renkaat Oyj’s ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Nokian Renkaat Oyj’s ROCE appears to be substantially greater than the 12% average in the Auto Components industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, Nokian Renkaat Oyj’s ROCE in absolute terms currently looks quite high.
In our analysis, Nokian Renkaat Oyj’s ROCE appears to be 26%, compared to 3 years ago, when its ROCE was 18%. This makes us think about whether the company has been reinvesting shrewdly.
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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Nokian Renkaat Oyj.
What Are Current Liabilities, And How Do They Affect Nokian Renkaat Oyj’s ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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.
Nokian Renkaat Oyj has total liabilities of €557m and total assets of €2.0b. As a result, its current liabilities are equal to approximately 28% of its total assets. This is quite a low level of current liabilities which would not greatly boost the already high ROCE.
What We Can Learn From Nokian Renkaat Oyj’s ROCE
Low current liabilities and high ROCE is a good combination, making Nokian Renkaat Oyj look quite interesting. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.