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Today we'll look at Wirecard AG (ETR:WDI) 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding 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. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. 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'.
How Do You Calculate Return On Capital Employed?
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 Wirecard:
0.14 = €561m ÷ (€6.7b - €2.7b) (Based on the trailing twelve months to June 2019.)
So, Wirecard has an ROCE of 14%.
Is Wirecard's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Wirecard's ROCE appears to be substantially greater than the 10% average in the IT 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. Regardless of where Wirecard sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
Our data shows that Wirecard currently has an ROCE of 14%, compared to its ROCE of 11% 3 years ago. This makes us think the business might be improving. You can click on the image below to see (in greater detail) how Wirecard's past growth compares to other companies.
It is important to remember that ROCE shows past performance, and is 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Wirecard.
Do Wirecard's Current Liabilities Skew Its ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Wirecard has total assets of €6.7b and current liabilities of €2.7b. As a result, its current liabilities are equal to approximately 41% of its total assets. With this level of current liabilities, Wirecard's ROCE is boosted somewhat.
What We Can Learn From Wirecard's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. There might be better investments than Wirecard 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.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.