Today we are going to look at Svedbergs i Dalstorp AB (publ) (STO:SVED B) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
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.
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. 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 Svedbergs i Dalstorp:
0.15 = kr49m ÷ (kr543m - kr220m) (Based on the trailing twelve months to September 2019.)
So, Svedbergs i Dalstorp has an ROCE of 15%.
Is Svedbergs i Dalstorp's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, Svedbergs i Dalstorp's ROCE appears to be around the 13% average of the Building industry. Regardless of where Svedbergs i Dalstorp sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, Svedbergs i Dalstorp currently has an ROCE of 15%, less than the 35% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how Svedbergs i Dalstorp's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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. ROCE is, after all, simply a snap shot of a single year. If Svedbergs i Dalstorp is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Svedbergs i Dalstorp's Current Liabilities Impact Its 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 counter this, investors can check if a company has high current liabilities relative to total assets.
Svedbergs i Dalstorp has total assets of kr543m and current liabilities of kr220m. As a result, its current liabilities are equal to approximately 41% of its total assets. With this level of current liabilities, Svedbergs i Dalstorp's ROCE is boosted somewhat.
Our Take On Svedbergs i Dalstorp's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. There might be better investments than Svedbergs i Dalstorp 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.
I will like Svedbergs i Dalstorp better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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