Today we'll look at Paul Hartmann AG (FRA:PHH2) 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.
First, we'll go over how we calculate ROCE. Then we'll compare its ROCE 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. All else being equal, a better business will have a higher ROCE. 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?
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 Paul Hartmann:
0.10 = €121m ÷ (€1.6b - €401m) (Based on the trailing twelve months to June 2019.)
So, Paul Hartmann has an ROCE of 10%.
Is Paul Hartmann's ROCE Good?
One way to assess ROCE is to compare similar companies. In this analysis, Paul Hartmann's ROCE appears meaningfully below the 14% average reported by the Medical Equipment industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from Paul Hartmann's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can click on the image below to see (in greater detail) how Paul Hartmann'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, after all, simply a snap shot of a single year. If Paul Hartmann is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.
How Paul Hartmann's Current Liabilities Impact Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Paul Hartmann has total liabilities of €401m and total assets of €1.6b. Therefore its current liabilities are equivalent to approximately 25% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
The Bottom Line On Paul Hartmann's ROCE
With that in mind, Paul Hartmann's ROCE appears pretty good. Paul Hartmann 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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