Gelsenwasser (FRA:WWG) Could Be Struggling To Allocate Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Gelsenwasser (FRA:WWG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Gelsenwasser:

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

0.01 = €45m ÷ (€12b - €7.3b) (Based on the trailing twelve months to June 2022).

So, Gelsenwasser has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Integrated Utilities industry average of 5.0%.

Our analysis indicates that WWG is potentially overvalued!

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Gelsenwasser has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Gelsenwasser's ROCE Trending?

On the surface, the trend of ROCE at Gelsenwasser doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.0% from 3.2% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 62%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

Our Take On Gelsenwasser's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Gelsenwasser. In light of this, the stock has only gained 11% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One more thing: We've identified 4 warning signs with Gelsenwasser (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.

While Gelsenwasser isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.