Today we'll look at Tomra Systems ASA (OB:TOM) 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. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. In general, businesses with a higher ROCE are usually better quality. 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?
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 Tomra Systems:
0.13 = kr1.2b ÷ (kr11b - kr1.4b) (Based on the trailing twelve months to June 2019.)
So, Tomra Systems has an ROCE of 13%.
Is Tomra Systems's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. In our analysis, Tomra Systems's ROCE is meaningfully higher than the 8.9% average in the Commercial Services industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of where Tomra Systems sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Tomra Systems's current ROCE of 13% is lower than 3 years ago, when the company reported a 18% ROCE. Therefore we wonder if the company is facing new headwinds. You can click on the image below to see (in greater detail) how Tomra Systems's past growth compares to other companies.
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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.
Do Tomra Systems's Current Liabilities Skew 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.
Tomra Systems has total assets of kr11b and current liabilities of kr1.4b. Therefore its current liabilities are equivalent to approximately 13% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Tomra Systems's ROCE
With that in mind, Tomra Systems's ROCE appears pretty good. Tomra Systems 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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.