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Today we'll look at UPM-Kymmene Oyj (HEL:UPM) and reflect on its potential as an investment. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. Finally, we'll look at how its current liabilities affect its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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'.
So, How Do We Calculate ROCE?
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 UPM-Kymmene Oyj:
0.11 = €1.4b ÷ (€15b - €2.1b) (Based on the trailing twelve months to March 2019.)
So, UPM-Kymmene Oyj has an ROCE of 11%.
Does UPM-Kymmene Oyj Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. It appears that UPM-Kymmene Oyj's ROCE is fairly close to the Forestry industry average of 9.6%. Independently of how UPM-Kymmene Oyj compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
Our data shows that UPM-Kymmene Oyj currently has an ROCE of 11%, compared to its ROCE of 7.0% 3 years ago. This makes us think about whether the company has been reinvesting shrewdly.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for UPM-Kymmene Oyj.
UPM-Kymmene Oyj's Current Liabilities And Their Impact On 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 counter this, investors can check if a company has high current liabilities relative to total assets.
UPM-Kymmene Oyj has total liabilities of €2.1b and total assets of €15b. As a result, its current liabilities are equal to approximately 14% of its total assets. Low current liabilities are not boosting the ROCE too much.
The Bottom Line On UPM-Kymmene Oyj's ROCE
Overall, UPM-Kymmene Oyj has a decent ROCE and could be worthy of further research. UPM-Kymmene Oyj shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
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 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.