Today we are going to look at Verallia Deutschland AG (FRA:OLG) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we'll go over how we calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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?
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 Verallia Deutschland:
0.28 = €78m ÷ (€464m - €189m) (Based on the trailing twelve months to December 2019.)
Therefore, Verallia Deutschland has an ROCE of 28%.
View our latest analysis for Verallia Deutschland
Does Verallia Deutschland Have A Good ROCE?
When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, Verallia Deutschland's ROCE is meaningfully higher than the 11% average in the Packaging industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Verallia Deutschland's ROCE currently appears to be excellent.
We can see that, Verallia Deutschland currently has an ROCE of 28% compared to its ROCE 3 years ago, which was 18%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Verallia Deutschland's ROCE compares to its industry, and you can click it to see more detail on its past growth.
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 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. How cyclical is Verallia Deutschland? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.