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Today we’ll look at Knowit AB (publ) (STO:KNOW) and reflect on its potential as an investment. 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. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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’.

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 Knowit:

0.25 = kr309m ÷ (kr1.9b – kr692m) (Based on the trailing twelve months to December 2018.)

Therefore, Knowit has an ROCE of 25%.

See our latest analysis for Knowit

Does Knowit Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. We can see Knowit’s ROCE is around the 23% average reported by the IT industry. Putting aside its position relative to its industry for now, in absolute terms, Knowit’s ROCE is currently very good.

In our analysis, Knowit’s ROCE appears to be 25%, compared to 3 years ago, when its ROCE was 14%. This makes us think about whether the company has been reinvesting shrewdly.

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Knowit.

What Are Current Liabilities, And How Do They Affect Knowit’s ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counter this, investors can check if a company has high current liabilities relative to total assets.