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Why You Should Care About NorCom Information Technology GmbH & Co. KGaA’s (ETR:NC5A) Low Return On Capital

Simply Wall St

Today we'll look at NorCom Information Technology GmbH & Co. KGaA (ETR:NC5A) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First up, we'll look at what ROCE is and how we calculate it. 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 measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. 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?

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 NorCom Information Technology GmbH KGaA:

0.069 = €638k ÷ (€15m - €5.8m) (Based on the trailing twelve months to June 2019.)

So, NorCom Information Technology GmbH KGaA has an ROCE of 6.9%.

See our latest analysis for NorCom Information Technology GmbH KGaA

Is NorCom Information Technology GmbH KGaA's ROCE Good?

ROCE is commonly used for comparing the performance of similar businesses. We can see NorCom Information Technology GmbH KGaA's ROCE is meaningfully below the IT 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. Aside from the industry comparison, NorCom Information Technology GmbH KGaA's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

NorCom Information Technology GmbH KGaA's current ROCE of 6.9% is lower than 3 years ago, when the company reported a 26% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how NorCom Information Technology GmbH KGaA's ROCE compares to its industry. Click to see more on past growth.

XTRA:NC5A Past Revenue and Net Income, November 18th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect NorCom Information Technology GmbH KGaA's ROCE?

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

NorCom Information Technology GmbH KGaA has total liabilities of €5.8m and total assets of €15m. As a result, its current liabilities are equal to approximately 39% of its total assets. NorCom Information Technology GmbH KGaA's middling level of current liabilities have the effect of boosting its ROCE a bit.

The Bottom Line On NorCom Information Technology GmbH KGaA's ROCE

With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like NorCom Information Technology GmbH KGaA better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider 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.