Today we are going to look at JM AB (publ) (STO:JM) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
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?
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 JM:
0.15 = kr1.9b ÷ (kr22b - kr9.8b) (Based on the trailing twelve months to September 2019.)
So, JM has an ROCE of 15%.
Does JM Have A Good ROCE?
One way to assess ROCE is to compare similar companies. In our analysis, JM's ROCE is meaningfully higher than the 12% average in the Consumer Durables industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Independently of how JM compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
JM's current ROCE of 15% is lower than 3 years ago, when the company reported a 23% ROCE. Therefore we wonder if the company is facing new headwinds. You can see in the image below how JM's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for JM.
What Are Current Liabilities, And How Do They Affect JM's ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
JM has total liabilities of kr9.8b and total assets of kr22b. Therefore its current liabilities are equivalent to approximately 44% of its total assets. JM has a medium level of current liabilities, which would boost the ROCE.
Our Take On JM's ROCE
While its ROCE looks good, it's worth remembering that the current liabilities are making the business look better. JM looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.
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.
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