In This Article:
Today we are going to look at Fernheizwerk Neukölln Aktiengesellschaft (FRA:FHW) 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 of all, we'll work out how to calculate ROCE. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. 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'.
How Do You Calculate Return On Capital Employed?
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 Fernheizwerk Neukölln:
0.14 = €8.9m ÷ (€66m - €4.0m) (Based on the trailing twelve months to December 2018.)
So, Fernheizwerk Neukölln has an ROCE of 14%.
Check out our latest analysis for Fernheizwerk Neukölln
Does Fernheizwerk Neukölln Have A Good ROCE?
One way to assess ROCE is to compare similar companies. Fernheizwerk Neukölln's ROCE appears to be substantially greater than the 5.9% average in the Water Utilities 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 Fernheizwerk Neukölln's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
You can see in the image below how Fernheizwerk Neukölln's ROCE compares to its industry. Click to see more on past growth.
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. How cyclical is Fernheizwerk Neukölln? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.
What Are Current Liabilities, And How Do They Affect Fernheizwerk Neukölln's ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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.