What Can We Make Of Frequentis AG’s (FRA:FQT) High Return On Capital?

Today we are going to look at Frequentis AG (FRA:FQT) to see whether it might be an attractive investment prospect. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. 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?

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 Frequentis:

0.14 = €16m ÷ (€198m - €82m) (Based on the trailing twelve months to December 2018.)

So, Frequentis has an ROCE of 14%.

View our latest analysis for Frequentis

Does Frequentis Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In our analysis, Frequentis's ROCE is meaningfully higher than the 9.3% average in the Aerospace & Defense 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. Separate from Frequentis's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. 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. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

What Are Current Liabilities, And How Do They Affect Frequentis's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counter this, investors can check if a company has high current liabilities relative to total assets.

Frequentis has total assets of €198m and current liabilities of €82m. As a result, its current liabilities are equal to approximately 42% of its total assets. Frequentis has a medium level of current liabilities, which would boost the ROCE.

Our Take On Frequentis's ROCE

Frequentis's ROCE does look good, but the level of current liabilities also contribute to that. Frequentis looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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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.