This analysis is intended to introduce important early concepts to people who are starting to invest and looking to gauge the potential return on investment in GEA Group Aktiengesellschaft (FRA:G1A).
Purchasing GEA Group gives you an ownership stake 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. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand GEA Group’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
What is Return on Capital Employed (ROCE)?
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. 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. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if GEA Group is good at growing investor capital. G1A’s ROCE is calculated below:
ROCE Calculation for G1A
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €297.01m ÷ (€5.76b – €1.88b) = 7.65%
The calculation above shows that G1A’s earnings were 7.65% of capital employed. Comparing this to a healthy 15% benchmark shows GEA Group is currently unable to return a satisfactory amount to owners for the use of their capital, which isn’t good for investors who have forgone other potentially solid companies.
What is causing this?
GEA Group’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment GEA Group 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. If you go back three years, you’ll find that G1A’s ROCE has decreased from 9.07%. With this, the current earnings of €297.01m actually declined from €389.44m whilst the amount of capital employed also fell but by a proportionally lesser volume, which suggests the smaller ROCE is due to a decline in earnings relative to capital requirements.
GEA Group’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 interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for G1A’s future growth? Take a look at our free research report of analyst consensus for G1A’s outlook.
- Valuation: What is G1A 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 G1A 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.