FRoSTA's (FRA:NLM) Returns On Capital Not Reflecting Well On The Business

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at FRoSTA (FRA:NLM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for FRoSTA, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.15 = €37m ÷ (€297m - €46m) (Based on the trailing twelve months to June 2021).

So, FRoSTA has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Food industry.

See our latest analysis for FRoSTA

Historical performance is a great place to start when researching a stock so above you can see the gauge for FRoSTA's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of FRoSTA, check out these free graphs here.

So How Is FRoSTA's ROCE Trending?

When we looked at the ROCE trend at FRoSTA, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 15% from 19% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, FRoSTA has done well to pay down its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From FRoSTA's ROCE

To conclude, we've found that FRoSTA is reinvesting in the business, but returns have been falling. And investors may be recognizing these trends since the stock has only returned a total of 32% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing: We've identified 3 warning signs with FRoSTA (at least 1 which is a bit concerning) , and understanding them would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.