Today we'll look at Slitevind AB (STO:SLITE) and reflect on its potential as an investment. 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.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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 Slitevind:
0.053 = kr31m ÷ (kr633m - kr50m) (Based on the trailing twelve months to September 2019.)
Therefore, Slitevind has an ROCE of 5.3%.
Is Slitevind's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see Slitevind's ROCE is around the 5.3% average reported by the Renewable Energy industry. Separate from how Slitevind stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. It is possible that there are more rewarding investments out there.
In our analysis, Slitevind's ROCE appears to be 5.3%, compared to 3 years ago, when its ROCE was 0.05%. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Slitevind's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is not necessarily predictive. 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. How cyclical is Slitevind? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
Slitevind's Current Liabilities And Their Impact On Its 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.
Slitevind has total liabilities of kr50m and total assets of kr633m. Therefore its current liabilities are equivalent to approximately 7.9% of its total assets. With low levels of current liabilities, at least Slitevind's mediocre ROCE is not unduly boosted.
What We Can Learn From Slitevind's ROCE
If performance improves, then Slitevind may be an OK investment, especially at the right valuation. 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.
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.
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