Today we'll look at Tikkurila Oyj (HEL:TIK1V) 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. Second, we'll look at its ROCE compared to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. In general, businesses with a higher ROCE are usually better quality. 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 Tikkurila Oyj:
0.15 = €40m ÷ (€530m - €270m) (Based on the trailing twelve months to June 2019.)
So, Tikkurila Oyj has an ROCE of 15%.
Is Tikkurila Oyj's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Tikkurila Oyj's ROCE is meaningfully higher than the 9.6% average in the Chemicals 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 Tikkurila Oyj compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
You can click on the image below to see (in greater detail) how Tikkurila Oyj's past growth compares to other companies.
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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Tikkurila Oyj.
Do Tikkurila Oyj's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.
Tikkurila Oyj has total assets of €530m and current liabilities of €270m. As a result, its current liabilities are equal to approximately 51% of its total assets. Tikkurila Oyj's current liabilities are fairly high, which increases its ROCE significantly.
The Bottom Line On Tikkurila Oyj'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 Tikkurila Oyj 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.
I will like Tikkurila Oyj better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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