Today we'll look at MTU Aero Engines AG (ETR:MTX) 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.
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 is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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?
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 MTU Aero Engines:
0.15 = €623m ÷ (€7.2b - €3.0b) (Based on the trailing twelve months to June 2019.)
So, MTU Aero Engines has an ROCE of 15%.
Is MTU Aero Engines's ROCE Good?
One way to assess ROCE is to compare similar companies. Using our data, we find that MTU Aero Engines's ROCE is meaningfully better than the 9.6% average in the Aerospace & Defense industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Separate from MTU Aero Engines's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
The image below shows how MTU Aero Engines's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for MTU Aero Engines.
Do MTU Aero Engines'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 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
MTU Aero Engines has total assets of €7.2b and current liabilities of €3.0b. As a result, its current liabilities are equal to approximately 41% of its total assets. MTU Aero Engines has a middling amount of current liabilities, increasing its ROCE somewhat.
The Bottom Line On MTU Aero Engines's ROCE
MTU Aero Engines's ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than MTU Aero Engines 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.
I will like MTU Aero Engines better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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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. Thank you for reading.