Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
Today we’ll look at Deutsche Telekom AG (FRA:DTE) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Then we’ll determine how its current liabilities are affecting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. 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 Deutsche Telekom:
0.079 = €10b ÷ (€165b – €37b) (Based on the trailing twelve months to March 2019.)
Therefore, Deutsche Telekom has an ROCE of 7.9%.
Does Deutsche Telekom Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. Using our data, we find that Deutsche Telekom’s ROCE is meaningfully better than the 6.0% average in the Telecom 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. 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.
As we can see, Deutsche Telekom currently has an ROCE of 7.9% compared to its ROCE 3 years ago, which was 6.3%. This makes us think about whether the company has been reinvesting shrewdly.
It is important to remember that ROCE shows past performance, and is 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Deutsche Telekom.
What Are Current Liabilities, And How Do They Affect Deutsche Telekom’s ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. 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 €165b and current liabilities of €37b. Therefore its current liabilities are equivalent to approximately 23% of its total assets. This is a modest level of current liabilities, which would only have a small effect on ROCE.
Our Take On Deutsche Telekom’s ROCE
That said, Deutsche Telekom’s ROCE is mediocre, there may be more attractive investments around. Of course, you might also be able to find a better stock than Deutsche Telekom. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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 email@example.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.