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Here’s why Railcare Group AB (publ)’s (STO:RAIL) Returns On Capital Matters So Much

Simply Wall St

Today we are going to look at Railcare Group AB (publ) ( STO:RAIL ) to see whether it might be an attractive investment prospect. To be precise, we'll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.

First of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. 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. 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?

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 Railcare Group:

0.021 = kr6.8m ÷ (kr463m - kr139m) (Based on the trailing twelve months to March 2019.)

Therefore, Railcare Group has an ROCE of 2.1%.

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Is Railcare Group's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Railcare Group's ROCE is meaningfully below the Infrastructure industry average of 11%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Regardless of how Railcare Group stacks up against its industry, its ROCE in absolute terms is quite low (especially compared to a bank account). It is likely that there are more attractive prospects out there.

As we can see, Railcare Group currently has an ROCE of 2.1%, less than the 9.9% it reported 3 years ago. So investors might consider if it has had issues recently.

OM:RAIL Past Revenue and Net Income, May 17th 2019

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 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 Railcare Group .

Railcare Group's Current Liabilities And Their Impact On Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 counter this, investors can check if a company has high current liabilities relative to total assets.

Railcare Group has total assets of kr463m and current liabilities of kr139m. Therefore its current liabilities are equivalent to approximately 30% of its total assets. In light of sufficient current liabilities to noticeably boost the ROCE, Railcare Group's ROCE is concerning.

What We Can Learn From Railcare Group's ROCE

This company may not be the most attractive investment prospect. Of course, you might also be able to find a better stock than Railcare Group . So you may wish to see this free collection of other companies that have grown earnings strongly.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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 editorial-team@simplywallst.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. Thank you for reading.