I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Grammer AG (FRA:GMM).
Purchasing Grammer gives you an ownership stake in the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. Your return is tied to GMM’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Thus, to understand how your money can grow by investing in Grammer, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
What is Return on Capital Employed (ROCE)?
Choosing to invest in Grammer comes at the cost of investing in another potentially favourable company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Grammer’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for GMM
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €60.84m ÷ (€1.07b – €388.18m) = 8.94%
The calculation above shows that GMM’s earnings were 8.94% of capital employed. This shows Grammer provides a dull capital return that is below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if GMM is clever with their reinvestments or dividend payments, investors can still grow their capital but may fall behind other more attractive opportunities in the market.
Why is this the case?
Grammer’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Grammer is in an adverse position, but this can change if these factors improve. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Looking three years in the past, it is evident that GMM’s ROCE has deteriorated from 9.21%, indicating the company’s capital returns have declined. Over the same period, EBT went from €52.01m to €60.84m but capital employed has grown by a proportionally greater amount due to a hike in the level of total assets , indicating that the previous growth in earnings has not been able to improve ROCE because the company now needs to employ more capital to operate the business.
Grammer’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate GMM or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for GMM’s future growth? Take a look at our free research report of analyst consensus for GMM’s outlook.
- Valuation: What is GMM worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether GMM is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.