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Are adesso AG’s (FRA:ADN1) High Returns Really That Great?

Simply Wall St

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Today we are going to look at adesso AG (FRA:ADN1) to see whether it might be an attractive investment prospect. 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. Next, we'll compare it to others in its industry. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. 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.'

So, How Do We Calculate ROCE?

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 adesso:

0.18 = €22m ÷ (€222m - €102m) (Based on the trailing twelve months to December 2018.)

Therefore, adesso has an ROCE of 18%.

See our latest analysis for adesso

Is adesso's ROCE Good?

When making comparisons between similar businesses, investors may find ROCE useful. In our analysis, adesso's ROCE is meaningfully higher than the 12% average in the IT industry. We would consider this a positive, as it suggests it is using capital more effectively than other similar companies. Setting aside the comparison to its industry for a moment, adesso's ROCE in absolute terms currently looks quite high.

Our data shows that adesso currently has an ROCE of 18%, compared to its ROCE of 15% 3 years ago. This makes us wonder if the company is improving.

DB:ADN1 Past Revenue and Net Income, April 6th 2019

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, after all, simply a snap shot of a single year. Future performance is what matters, and you can see analyst predictions in our free report on analyst forecasts for the company.

How adesso's Current Liabilities Impact Its ROCE

Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, 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 counter this, investors can check if a company has high current liabilities relative to total assets.

adesso has total assets of €222m and current liabilities of €102m. As a result, its current liabilities are equal to approximately 46% of its total assets. A medium level of current liabilities boosts adesso's ROCE somewhat.

What We Can Learn From adesso's ROCE

Despite this, it reports a high ROCE, and may be worth investigating further. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.

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.

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. Thank you for reading.