New Zealand Markets closed

Why You Should Care About Footway Group AB (publ)’s (STO:FOOT B) Low Return On Capital

Simply Wall St

Today we'll look at Footway Group AB (publ) (STO:FOOT B) and reflect on its potential as an investment. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.

First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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?

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 Footway Group:

0.067 = kr16m ÷ (kr695m - kr461m) (Based on the trailing twelve months to September 2019.)

Therefore, Footway Group has an ROCE of 6.7%.

See our latest analysis for Footway Group

Does Footway Group Have A Good ROCE?

One way to assess ROCE is to compare similar companies. We can see Footway Group's ROCE is meaningfully below the Online Retail industry average of 12%. This performance could be negative if sustained, as it suggests the business may underperform its industry. Aside from the industry comparison, Footway Group's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. It is possible that there are more rewarding investments out there.

Our data shows that Footway Group currently has an ROCE of 6.7%, compared to its ROCE of 1.9% 3 years ago. This makes us think the business might be improving. You can see in the image below how Footway Group's ROCE compares to its industry. Click to see more on past growth.

OM:FOOT B Past Revenue and Net Income, October 17th 2019

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 deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Footway Group has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Footway Group'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 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.

Footway Group has total assets of kr695m and current liabilities of kr461m. As a result, its current liabilities are equal to approximately 66% of its total assets. Footway Group has a fairly high level of current liabilities, meaningfully impacting its ROCE.

What We Can Learn From Footway Group's ROCE

Despite this, the company also has a uninspiring ROCE, which is not an ideal combination in this analysis. Of course, you might also be able to find a better stock than Footway Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Footway Group better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

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.