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Today we are going to look at Deutsche Telekom AG (FRA:DTE) to see whether it might be an attractive investment prospect. To be precise, we’ll consider its Return On Capital Employed (ROCE), as that will inform our view of the quality of the business.
First up, we’ll look at what ROCE is and how we calculate it. Next, we’ll compare it to others in its industry. Finally, we’ll look at how its current liabilities affect its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Deutsche Telekom:
0.079 = €9.2b ÷ (€142b – €24b) (Based on the trailing twelve months to September 2018.)
So, Deutsche Telekom has an ROCE of 7.9%.
Is Deutsche Telekom’s ROCE Good?
ROCE is commonly used for comparing the performance of similar businesses. Using our data, Deutsche Telekom’s ROCE appears to be around the 6.8% average of the Telecom industry. Separate from how Deutsche Telekom stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Investors may wish to consider higher-performing investments.
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 only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Deutsche Telekom.
Deutsche Telekom’s Current Liabilities And Their Impact On Its ROCE
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Deutsche Telekom has total assets of €142b and current liabilities of €24b. Therefore its current liabilities are equivalent to approximately 17% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
What We Can Learn From Deutsche Telekom’s ROCE
If Deutsche Telekom continues to earn an uninspiring ROCE, there may be better places to invest. You might be able to find a better buy than Deutsche Telekom. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
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.