Today we'll look at Regenbogen AG ( FRA:RGB ) 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting 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. In brief, it is a useful tool, but it is not without drawbacks. 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 Regenbogen:
0.042 = €747k ÷ (€24m - €6.4m) (Based on the trailing twelve months to December 2018.)
Therefore, Regenbogen has an ROCE of 4.2%.
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Does Regenbogen Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Regenbogen's ROCE is meaningfully below the Hospitality industry average of 5.9%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Regenbogen'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.
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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Regenbogen is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow .
Do Regenbogen'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.
Regenbogen has total assets of €24m and current liabilities of €6.4m. Therefore its current liabilities are equivalent to approximately 26% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.
What We Can Learn From Regenbogen's ROCE
With that in mind, we're not overly impressed with Regenbogen's ROCE, so it may not be the most appealing prospect. Of course, you might also be able to find a better stock than Regenbogen . So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.