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Why ABO-Group Environment NV’s (EBR:ABO) Return On Capital Employed Might Be A Concern

Simply Wall St

Today we'll look at ABO-Group Environment NV (EBR:ABO) 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.

Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

Understanding 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. 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.

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 ABO-Group Environment:

0.059 = €1.6m ÷ (€49m - €22m) (Based on the trailing twelve months to June 2019.)

Therefore, ABO-Group Environment has an ROCE of 5.9%.

Check out our latest analysis for ABO-Group Environment

Is ABO-Group Environment's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. Using our data, ABO-Group Environment's ROCE appears to be significantly below the 9.1% average in the Commercial Services industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, ABO-Group Environment's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

In our analysis, ABO-Group Environment's ROCE appears to be 5.9%, compared to 3 years ago, when its ROCE was 1.1%. This makes us wonder if the company is improving. The image below shows how ABO-Group Environment's ROCE compares to its industry, and you can click it to see more detail on its past growth.

ENXTBR:ABO Past Revenue and Net Income, November 9th 2019

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. You can check if ABO-Group Environment has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

Do ABO-Group Environment'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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

ABO-Group Environment has total liabilities of €22m and total assets of €49m. As a result, its current liabilities are equal to approximately 45% of its total assets. ABO-Group Environment's middling level of current liabilities have the effect of boosting its ROCE a bit.

The Bottom Line On ABO-Group Environment's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.