U.S. Markets open in 8 hrs 57 mins

Why We’re Not Keen On OSRAM Licht AG’s (ETR:OSR) 6.1% Return On Capital

Petra Goodwin

Today we’ll look at OSRAM Licht AG (ETR:OSR) 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.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.

Understanding 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 OSRAM Licht:

0.061 = €195m ÷ (€4.7b – €1.6b) (Based on the trailing twelve months to September 2018.)

Therefore, OSRAM Licht has an ROCE of 6.1%.

View our latest analysis for OSRAM Licht

Is OSRAM Licht’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, OSRAM Licht’s ROCE appears to be significantly below the 10% average in the Electrical industry. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, OSRAM Licht’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.

As we can see, OSRAM Licht currently has an ROCE of 6.1%, less than the 9.0% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds.

XTRA:OSR Last Perf January 24th 19

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 only a point-in-time measure. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How OSRAM Licht’s Current Liabilities Impact 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

OSRAM Licht has total assets of €4.7b and current liabilities of €1.6b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. OSRAM Licht’s ROCE is improved somewhat by its moderate amount of current liabilities.

Our Take On OSRAM Licht’s ROCE

Unfortunately, its ROCE is still uninspiring, and there are potentially more attractive prospects out there. You might be able to find a better buy than OSRAM Licht. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.