What Can We Make Of FRoSTA Aktiengesellschaft’s (FRA:NLM) High Return On Capital?

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Today we are going to look at FRoSTA Aktiengesellschaft (FRA:NLM) to see whether it might be an attractive investment prospect. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

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

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Overall, it is a valuable metric that has its flaws. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

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

Or for FRoSTA:

0.15 = €30m ÷ (€329m – €130m) (Based on the trailing twelve months to December 2018.)

So, FRoSTA has an ROCE of 15%.

Check out our latest analysis for FRoSTA

Is FRoSTA’s ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that FRoSTA’s ROCE is meaningfully better than the 12% average in the Food 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. Independently of how FRoSTA compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

DB:NLM Past Revenue and Net Income, June 10th 2019
DB:NLM Past Revenue and Net Income, June 10th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

Do FRoSTA’s Current Liabilities Skew Its ROCE?

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

FRoSTA has total assets of €329m and current liabilities of €130m. Therefore its current liabilities are equivalent to approximately 39% of its total assets. With this level of current liabilities, FRoSTA’s ROCE is boosted somewhat.

Our Take On FRoSTA’s ROCE

FRoSTA’s ROCE does look good, but the level of current liabilities also contribute to that. There might be better investments than FRoSTA out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.

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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.