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What Can We Make Of Telenor ASA’s (OB:TEL) High Return On Capital?

Simply Wall St

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Today we'll look at Telenor ASA (OB:TEL) 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, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. 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. 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.'

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 Telenor:

0.18 = øre26b ÷ (øre219b - øre75b) (Based on the trailing twelve months to March 2019.)

So, Telenor has an ROCE of 18%.

Check out our latest analysis for Telenor

Does Telenor Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Telenor's ROCE is meaningfully higher than the 7.9% average in the Telecom industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how Telenor compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

You can see in the image below how Telenor's ROCE compares to its industry. Click to see more on past growth.

OB:TEL Past Revenue and Net Income, June 28th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Telenor.

Do Telenor's Current Liabilities Skew Its ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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.

Telenor has total liabilities of øre75b and total assets of øre219b. As a result, its current liabilities are equal to approximately 34% of its total assets. Telenor has a middling amount of current liabilities, increasing its ROCE somewhat.

Our Take On Telenor's ROCE

While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. Telenor looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

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.

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. Thank you for reading.