Today we'll look at Adler Modemärkte AG (ETR:ADD) and reflect on its potential as an investment. 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.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. 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?
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 Adler Modemärkte:
0.091 = €27m ÷ (€409m - €108m) (Based on the trailing twelve months to December 2019.)
Therefore, Adler Modemärkte has an ROCE of 9.1%.
Does Adler Modemärkte Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Using our data, Adler Modemärkte's ROCE appears to be around the 7.8% average of the Specialty Retail industry. Independently of how Adler Modemärkte compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.
We can see that, Adler Modemärkte currently has an ROCE of 9.1% compared to its ROCE 3 years ago, which was 2.8%. This makes us think about whether the company has been reinvesting shrewdly. You can click on the image below to see (in greater detail) how Adler Modemärkte's past growth compares to other companies.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. 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 Adler Modemärkte.
Do Adler Modemärkte's Current Liabilities Skew Its ROCE?
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills 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 counteract this, we check if a company has high current liabilities, relative to its total assets.
Adler Modemärkte has total assets of €409m and current liabilities of €108m. As a result, its current liabilities are equal to approximately 26% of its total assets. A fairly low level of current liabilities is not influencing the ROCE too much.
Our Take On Adler Modemärkte's ROCE
Overall, Adler Modemärkte has a decent ROCE and could be worthy of further research. Adler Modemärkte looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
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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