In This Article:
Today we'll evaluate AB Fagerhult (STO:FAG) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.
What is 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. 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?
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 AB Fagerhult:
0.065 = kr726m ÷ (kr13b - kr2.0b) (Based on the trailing twelve months to June 2019.)
So, AB Fagerhult has an ROCE of 6.5%.
Check out our latest analysis for AB Fagerhult
Is AB Fagerhult's ROCE Good?
One way to assess ROCE is to compare similar companies. We can see AB Fagerhult's ROCE is meaningfully below the Electrical industry average of 10.0%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Aside from the industry comparison, AB Fagerhult's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.
We can see that, AB Fagerhult currently has an ROCE of 6.5%, less than the 13% it reported 3 years ago. Therefore we wonder if the company is facing new headwinds. You can see in the image below how AB Fagerhult's ROCE compares to its industry. Click to see more on past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for AB Fagerhult.
Do AB Fagerhult'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 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.