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Today we'll evaluate Vestas Wind Systems A/S (CPH:VWS) to determine whether it could have potential as an investment idea. 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. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Generally speaking a higher ROCE is better. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 Vestas Wind Systems:
0.22 = €968m ÷ (€12b - €7.4b) (Based on the trailing twelve months to December 2018.)
So, Vestas Wind Systems has an ROCE of 22%.
Does Vestas Wind Systems Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Vestas Wind Systems's ROCE is meaningfully better than the 12% average in the Electrical 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. Setting aside the comparison to its industry for a moment, Vestas Wind Systems's ROCE in absolute terms currently looks quite high.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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, after all, simply a snap shot of a single year. Since the future is so important for investors, you should check out our free report on analyst forecasts for Vestas Wind Systems.
What Are Current Liabilities, And How Do They Affect Vestas Wind Systems's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
Vestas Wind Systems has total assets of €12b and current liabilities of €7.4b. As a result, its current liabilities are equal to approximately 62% of its total assets. Vestas Wind Systems's high level of current liabilities boost the ROCE - but its ROCE is still impressive.
Our Take On Vestas Wind Systems's ROCE
In my book, this business could be worthy of further research. Of course you might be able to find a better stock than Vestas Wind Systems. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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.