Investors Met With Slowing Returns on Capital At freenet (ETR:FNTN)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating freenet (ETR:FNTN), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for freenet:

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

0.066 = €142m ÷ (€3.3b - €1.2b) (Based on the trailing twelve months to June 2023).

Thus, freenet has an ROCE of 6.6%. In absolute terms, that's a low return but it's around the Wireless Telecom industry average of 8.0%.

Check out our latest analysis for freenet

In the above chart we have measured freenet's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for freenet.

What The Trend Of ROCE Can Tell Us

Over the past five years, freenet's ROCE has remained relatively flat while the business is using 40% less capital than before. This indicates to us that assets are being sold and thus the business is likely shrinking, which you'll remember isn't the typical ingredients for an up-and-coming multi-bagger. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 35% of total assets, this reported ROCE would probably be less than6.6% because total capital employed would be higher.The 6.6% ROCE could be even lower if current liabilities weren't 35% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.

In Conclusion...

Overall, we're not ecstatic to see freenet reducing the amount of capital it employs in the business. Since the stock has gained an impressive 41% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

freenet does have some risks though, and we've spotted 2 warning signs for freenet that you might be interested in.

While freenet may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.