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Shareholders Should Look Hard At Salzgitter AG’s (ETR:SZG) 0.8%Return On Capital

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Today we'll evaluate Salzgitter AG (ETR:SZG) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. 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.

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 Salzgitter:

0.0078 = €53m ÷ (€9.1b - €2.3b) (Based on the trailing twelve months to September 2019.)

So, Salzgitter has an ROCE of 0.8%.

Check out our latest analysis for Salzgitter

Does Salzgitter Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Salzgitter's ROCE is meaningfully below the Metals and Mining industry average of 9.0%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside Salzgitter's performance relative to its industry, its ROCE in absolute terms is poor - considering the risk of owning stocks compared to government bonds. It is likely that there are more attractive prospects out there.

Our data shows that Salzgitter currently has an ROCE of 0.8%, compared to its ROCE of 0.2% 3 years ago. This makes us think the business might be improving. You can see in the image below how Salzgitter's ROCE compares to its industry. Click to see more on past growth.

XTRA:SZG Past Revenue and Net Income, December 3rd 2019
XTRA:SZG Past Revenue and Net Income, December 3rd 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Given the industry it operates in, Salzgitter could be considered cyclical. Since the future is so important for investors, you should check out our free report on analyst forecasts for Salzgitter.

How Salzgitter's Current Liabilities Impact 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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Salzgitter has total assets of €9.1b and current liabilities of €2.3b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. With a very reasonable level of current liabilities, so the impact on ROCE is fairly minimal.

What We Can Learn From Salzgitter's ROCE

While that is good to see, Salzgitter has a low ROCE and does not look attractive in this analysis. You might be able to find a better investment than Salzgitter. 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).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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.