Today we'll look at Deutsche Lufthansa AG (ETR:LHA) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its 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. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed 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?
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 Deutsche Lufthansa:
0.071 = €1.9b ÷ (€44b - €18b) (Based on the trailing twelve months to September 2019.)
So, Deutsche Lufthansa has an ROCE of 7.1%.
Is Deutsche Lufthansa's ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. We can see Deutsche Lufthansa's ROCE is meaningfully below the Airlines industry average of 10%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Deutsche Lufthansa'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.
You can see in the image below how Deutsche Lufthansa's ROCE compares to its industry. Click to see more on 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. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Deutsche Lufthansa.
What Are Current Liabilities, And How Do They Affect Deutsche Lufthansa's 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Deutsche Lufthansa has total assets of €44b and current liabilities of €18b. Therefore its current liabilities are equivalent to approximately 40% of its total assets. Deutsche Lufthansa's ROCE is improved somewhat by its moderate amount of current liabilities.
Our Take On Deutsche Lufthansa's ROCE
With this level of liabilities and a mediocre ROCE, there are potentially better investments out there. You might be able to find a better investment than Deutsche Lufthansa. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.
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