Yahoo Finance Why You Should Care About Telefonaktiebolaget LM Ericsson (publ)’s (STO:ERIC B) Low Return On Capital
Today we'll look at Telefonaktiebolaget LM Ericsson (publ) (STO:ERIC B) and reflect on its potential as an investment. 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, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared 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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
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 Telefonaktiebolaget LM Ericsson:
0.098 = kr16b ÷ (kr280b - kr115b) (Based on the trailing twelve months to June 2019.)
So, Telefonaktiebolaget LM Ericsson has an ROCE of 9.8%.
View our latest analysis for Telefonaktiebolaget LM Ericsson
Does Telefonaktiebolaget LM Ericsson Have A Good ROCE?
One way to assess ROCE is to compare similar companies. We can see Telefonaktiebolaget LM Ericsson's ROCE is meaningfully below the Communications industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Separate from Telefonaktiebolaget LM Ericsson's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
We can see that , Telefonaktiebolaget LM Ericsson currently has an ROCE of 9.8%, less than the 15% it reported 3 years ago. So investors might consider if it has had issues recently. You can click on the image below to see (in greater detail) how Telefonaktiebolaget LM Ericsson's past growth compares to other companies.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Telefonaktiebolaget LM Ericsson.
What Are Current Liabilities, And How Do They Affect Telefonaktiebolaget LM Ericsson's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.
Telefonaktiebolaget LM Ericsson has total assets of kr280b and current liabilities of kr115b. Therefore its current liabilities are equivalent to approximately 41% of its total assets. Telefonaktiebolaget LM Ericsson has a middling amount of current liabilities, increasing its ROCE somewhat.
Our Take On Telefonaktiebolaget LM Ericsson's ROCE
With a decent ROCE, the company could be interesting, but remember that the level of current liabilities make the ROCE look better. Telefonaktiebolaget LM Ericsson shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
