In This Article:
Today we are going to look at Frontier Developments plc (LON:FDEV) to see whether it might be an attractive investment prospect. In particular, we'll consider its Return On Capital Employed (ROCE), as that can give us insight into how profitably the company is able to employ capital in its business.
First of all, we'll work out how to calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect 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. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. 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'.
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 Frontier Developments:
0.27 = UK£19m ÷ (UK£84m - UK£11m) (Based on the trailing twelve months to May 2019.)
Therefore, Frontier Developments has an ROCE of 27%.
See our latest analysis for Frontier Developments
Is Frontier Developments's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Frontier Developments's ROCE is meaningfully better than the 6.2% average in the Entertainment 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. Putting aside its position relative to its industry for now, in absolute terms, Frontier Developments's ROCE is currently very good.
In our analysis, Frontier Developments's ROCE appears to be 27%, compared to 3 years ago, when its ROCE was 5.1%. This makes us think the business might be improving. You can see in the image below how Frontier Developments's ROCE compares to its industry. Click to see more on past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Frontier Developments.