Today we'll look at Elmos Semiconductor AG (ETR:ELG) and reflect on its potential as an investment. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on 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. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.
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 Elmos Semiconductor:
0.13 = €51m ÷ (€444m - €50m) (Based on the trailing twelve months to September 2019.)
Therefore, Elmos Semiconductor has an ROCE of 13%.
Is Elmos Semiconductor's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. We can see Elmos Semiconductor's ROCE is around the 12% average reported by the Semiconductor industry. Independently of how Elmos Semiconductor compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
In our analysis, Elmos Semiconductor's ROCE appears to be 13%, compared to 3 years ago, when its ROCE was 7.2%. This makes us think about whether the company has been reinvesting shrewdly. The image below shows how Elmos Semiconductor's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Elmos Semiconductor.
How Elmos Semiconductor's Current Liabilities Impact 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Elmos Semiconductor has current liabilities of €50m and total assets of €444m. As a result, its current liabilities are equal to approximately 11% of its total assets. Current liabilities are minimal, limiting the impact on ROCE.
Our Take On Elmos Semiconductor's ROCE
With that in mind, Elmos Semiconductor's ROCE appears pretty good. There might be better investments than Elmos Semiconductor out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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