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Why You Should Care About Heidelberger Druckmaschinen Aktiengesellschaft’s (FRA:HDD) Low Return On Capital

Simply Wall St

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Today we are going to look at Heidelberger Druckmaschinen Aktiengesellschaft (FRA:HDD) to see whether it might be an attractive investment prospect. 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, 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.

What is Return On Capital Employed (ROCE)?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Overall, it is a valuable metric that has its flaws. 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 Heidelberger Druckmaschinen:

0.063 = €94m ÷ (€2.3b - €834m) (Based on the trailing twelve months to March 2019.)

Therefore, Heidelberger Druckmaschinen has an ROCE of 6.3%.

View our latest analysis for Heidelberger Druckmaschinen

Is Heidelberger Druckmaschinen's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see Heidelberger Druckmaschinen's ROCE is meaningfully below the Machinery industry average of 10%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Heidelberger Druckmaschinen stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.

DB:HDD Past Revenue and Net Income, June 24th 2019

When considering this metric, keep in mind that it is backwards looking, and 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Heidelberger Druckmaschinen's Current Liabilities And Their Impact On Its ROCE

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Heidelberger Druckmaschinen has total assets of €2.3b and current liabilities of €834m. Therefore its current liabilities are equivalent to approximately 36% of its total assets. Heidelberger Druckmaschinen's ROCE is improved somewhat by its moderate amount of current liabilities.

What We Can Learn From Heidelberger Druckmaschinen's ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects 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 like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.