Are Novozymes A/S’s (CPH:NZYM B) High Returns Really That Great?

Today we'll look at Novozymes A/S (CPH:NZYM B) 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. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting 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 Novozymes:

0.26 = ø3.8b ÷ (ø20b - ø5.3b) (Based on the trailing twelve months to September 2019.)

So, Novozymes has an ROCE of 26%.

View our latest analysis for Novozymes

Is Novozymes's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Novozymes's ROCE is meaningfully better than the 9.6% average in the Chemicals industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Setting aside the comparison to its industry for a moment, Novozymes's ROCE in absolute terms currently looks quite high.

You can click on the image below to see (in greater detail) how Novozymes's past growth compares to other companies.

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. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Novozymes's Current Liabilities And Their Impact On 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 counteract this, we check if a company has high current liabilities, relative to its total assets.

Novozymes has total liabilities of ø5.3b and total assets of ø20b. Therefore its current liabilities are equivalent to approximately 26% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.

The Bottom Line On Novozymes's ROCE

With low current liabilities and a high ROCE, Novozymes could be worthy of further investigation. Novozymes 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.

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 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.

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