Today we'll look at Stadler Rail AG (VTX:SRAIL) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
Return On Capital Employed (ROCE): What is it?
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. 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 Stadler Rail:
0.16 = CHF163m ÷ (CHF3.0b - CHF2.0b) (Based on the trailing twelve months to June 2019.)
So, Stadler Rail has an ROCE of 16%.
Is Stadler Rail's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Stadler Rail's ROCE is meaningfully higher than the 14% average in the Machinery industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Regardless of where Stadler Rail sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
You can see in the image below how Stadler Rail'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. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during 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.
Do Stadler Rail's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.
Stadler Rail has current liabilities of CHF2.0b and total assets of CHF3.0b. Therefore its current liabilities are equivalent to approximately 67% of its total assets. Stadler Rail has a relatively high level of current liabilities, boosting its ROCE meaningfully.
What We Can Learn From Stadler Rail's ROCE
This ROCE is pretty good, but remember that it would look less impressive with fewer current liabilities. There might be better investments than Stadler Rail 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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