1&1 (ETR:1U1) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating 1&1 (ETR:1U1), we don't think it's current trends fit the mold of a multi-bagger.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for 1&1, this is the formula:

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

0.099 = €618m ÷ (€6.8b - €608m) (Based on the trailing twelve months to March 2021).

So, 1&1 has an ROCE of 9.9%. In absolute terms, that's a low return but it's around the Wireless Telecom industry average of 8.3%.

See our latest analysis for 1&1

Above you can see how the current ROCE for 1&1 compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For 1&1 Tell Us?

In terms of 1&1's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 22% over the last four years. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, 1&1 has decreased its current liabilities to 8.9% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On 1&1's ROCE

Bringing it all together, while we're somewhat encouraged by 1&1's reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 46% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a separate note, we've found 2 warning signs for 1&1 you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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