Today we'll look at InnoTec TSS AG (FRA:TSS) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect 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. In brief, it is a useful tool, but it is not without drawbacks. 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?
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 InnoTec TSS:
0.12 = €12m ÷ (€105m - €11m) (Based on the trailing twelve months to December 2018.)
So, InnoTec TSS has an ROCE of 12%.
Does InnoTec TSS Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that InnoTec TSS's ROCE is meaningfully better than the 6.6% average in the Building industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Separate from InnoTec TSS's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that , InnoTec TSS currently has an ROCE of 12%, less than the 22% it reported 3 years ago. This makes us wonder if the business is facing new challenges. You can click on the image below to see (in greater detail) how InnoTec TSS's past growth compares to other companies.
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. ROCE is, after all, simply a snap shot of a single year. You can check if InnoTec TSS has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.
Do InnoTec TSS's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.
InnoTec TSS has total liabilities of €11m and total assets of €105m. Therefore its current liabilities are equivalent to approximately 10% of its total assets. Low current liabilities are not boosting the ROCE too much.
What We Can Learn From InnoTec TSS's ROCE
This is good to see, and with a sound ROCE, InnoTec TSS could be worth a closer look. There might be better investments than InnoTec TSS 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.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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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. Thank you for reading.