Today we'll evaluate Vidrala, S.A. (BME:VID) to determine whether it could have potential as an investment idea. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
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. Overall, it is a valuable metric that has its flaws. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Vidrala:
0.17 = €180m ÷ (€1.5b - €403m) (Based on the trailing twelve months to December 2019.)
So, Vidrala has an ROCE of 17%.
Is Vidrala's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Vidrala's ROCE appears to be substantially greater than the 11% average in the Packaging 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. Regardless of where Vidrala 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, Vidrala currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 11%. This makes us think the business might be improving. You can see in the image below how Vidrala's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Vidrala.
How Vidrala's Current Liabilities Impact Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Vidrala has total assets of €1.5b and current liabilities of €403m. Therefore its current liabilities are equivalent to approximately 28% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
The Bottom Line On Vidrala's ROCE
With that in mind, Vidrala's ROCE appears pretty good. There might be better investments than Vidrala 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.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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