What Should Investors Know About LEONI AG’s (FRA:LEO) Return On Capital?

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 LEONI AG (FRA:LEO).

LEONI stock represents an ownership share in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. Your return is tied to LEO’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. Therefore, looking at how efficiently LEONI is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.

Check out our latest analysis for LEONI

What is Return on Capital Employed (ROCE)?

As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. We’ll look at LEONI’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 LEO

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = €182m ÷ (€3.4b – €1.7b) = 11%

As you can see, LEO earned €10.6 from every €100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows LEONI is currently unable to return a desired amount to owners for the use of their capital, which isn’t favourable for investors who have forgone other potentially solid companies.

DB:LEO Last Perf November 13th 18
DB:LEO Last Perf November 13th 18

Why is this the case?

LEO doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. 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 at the past 3 year period shows us that LEO boosted investor return on capital employed from 8.0%. Similarly, the movement in the earnings variable shows a jump from €141m to €182m whilst capital employed has declined in response to a greater amount of current liabilities used (meaning the company has used more borrowed money than shareholder capital to produce earnings) , which means the company has been able to improve ROCE by growing earnings and simultaneously putting less capital to work.

Next Steps

ROCE for LEO investors is below the desired level at the moment, however, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation to determine if an opportunity exists that isn’t made apparent by looking at past data. 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 LEO or move on to other alternatives.

  1. Future Outlook: What are well-informed industry analysts predicting for LEO’s future growth? Take a look at our free research report of analyst consensus for LEO’s outlook.
  2. Valuation: What is LEO 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 LEO is currently undervalued by the market.
  3. 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 editorial-team@simplywallst.com.