Today we'll evaluate Holmen Aktiebolag (publ.) (STO:HOLM B) 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.
First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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 Holmen Aktiebolag (publ.):
0.031 = kr1.7b ÷ (kr59b - kr6.1b) (Based on the trailing twelve months to December 2019.)
So, Holmen Aktiebolag (publ.) has an ROCE of 3.1%.
Does Holmen Aktiebolag (publ.) Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Holmen Aktiebolag (publ.)'s ROCE appears meaningfully below the 7.5% average reported by the Forestry industry. 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, Holmen Aktiebolag (publ.)'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.
Holmen Aktiebolag (publ.)'s current ROCE of 3.1% is lower than its ROCE in the past, which was 5.5%, 3 years ago. Therefore we wonder if the company is facing new headwinds. The image below shows how Holmen Aktiebolag (publ.)'s ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately 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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Holmen Aktiebolag (publ.).
What Are Current Liabilities, And How Do They Affect Holmen Aktiebolag (publ.)'s ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that 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.
Holmen Aktiebolag (publ.) has total assets of kr59b and current liabilities of kr6.1b. As a result, its current liabilities are equal to approximately 10% of its total assets. It is good to see a restrained amount of current liabilities, as this limits the effect on ROCE.
What We Can Learn From Holmen Aktiebolag (publ.)'s ROCE
If Holmen Aktiebolag (publ.) continues to earn an uninspiring ROCE, there may be better places to invest. Of course, you might also be able to find a better stock than Holmen Aktiebolag (publ.). So you may wish to see this free collection of other companies that have grown earnings strongly.
I will like Holmen Aktiebolag (publ.) better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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