In This Article:
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.