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Is 1&1 Drillisch AG's (ETR:DRI) Capital Allocation Ability Worth Your Time?

Simply Wall St

Today we'll evaluate 1&1 Drillisch AG (ETR:DRI) to determine whether it could have potential as an investment idea. 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.

First up, we'll look at what ROCE is and how we calculate it. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

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. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

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 1&1 Drillisch:

0.093 = €547m ÷ (€6.4b - €510m) (Based on the trailing twelve months to September 2019.)

So, 1&1 Drillisch has an ROCE of 9.3%.

See our latest analysis for 1&1 Drillisch

Is 1&1 Drillisch's ROCE Good?

One way to assess ROCE is to compare similar companies. We can see 1&1 Drillisch's ROCE is around the 8.3% average reported by the Wireless Telecom industry. Separate from 1&1 Drillisch's performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.

The image below shows how 1&1 Drillisch's ROCE compares to its industry, and you can click it to see more detail on its past growth.

XTRA:DRI Past Revenue and Net Income, January 29th 2020

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 misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for 1&1 Drillisch.

What Are Current Liabilities, And How Do They Affect 1&1 Drillisch's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. 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.

1&1 Drillisch has total assets of €6.4b and current liabilities of €510m. Therefore its current liabilities are equivalent to approximately 8.0% of its total assets. With low current liabilities, 1&1 Drillisch's decent ROCE looks that much more respectable.

Our Take On 1&1 Drillisch's ROCE

This is good to see, and while better prospects may exist, 1&1 Drillisch seems worth researching further. 1&1 Drillisch shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.

If you are like me, then you will not want to miss this free list of growing companies that insiders are buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.