This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Fonterra Co-operative Group Limited (NZSE:FCG)’s return fundamentals and stock market performance.
Purchasing Fonterra Co-operative Group gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Fonterra Co-operative Group’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
Fonterra Co-operative Group’s Return On Capital Employed
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Fonterra Co-operative Group is good at growing investor capital. Take a look at the formula box beneath:
ROCE Calculation for FCG
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = NZ$229m ÷ (NZ$18.0b – NZ$5.1b) = 1.8%
The calculation above shows that FCG’s earnings were 1.8% of capital employed. This makes Fonterra Co-operative Group disappointing when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital may be able to compound over time, but not to standard that investors should be aiming for.
What is causing this?
FCG doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking at the past 3 year period shows us that FCG weakened investor return on capital employed from 2.8%. In this time, earnings have fallen from NZ$372m to NZ$229m and the amount of capital employed also fell but by a proportionally lesser volume, which suggests the smaller ROCE is due to a decline in earnings relative to capital requirements.
ROCE for FCG investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for FCG’s future growth? Take a look at our free research report of analyst consensus for FCG’s outlook.
- Valuation: What is FCG worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether FCG is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 firstname.lastname@example.org.