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Why Fresenius Medical Care AG & Co. KGaA’s (ETR:FME) Return On Capital Employed Is Impressive

Simply Wall St

Today we'll look at Fresenius Medical Care AG & Co. KGaA (ETR:FME) and reflect on its potential as an investment. 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 up, we'll look at what ROCE is and how we calculate it. Then we'll compare its ROCE 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.

So, How Do We Calculate ROCE?

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 Fresenius Medical Care KGaA:

0.085 = €2.2b ÷ (€33b - €7.4b) (Based on the trailing twelve months to September 2019.)

Therefore, Fresenius Medical Care KGaA has an ROCE of 8.5%.

See our latest analysis for Fresenius Medical Care KGaA

Is Fresenius Medical Care KGaA's ROCE Good?

One way to assess ROCE is to compare similar companies. In our analysis, Fresenius Medical Care KGaA's ROCE is meaningfully higher than the 6.6% average in the Healthcare 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. Independently of how Fresenius Medical Care KGaA compares to its industry, its ROCE in absolute terms appears decent, and the company may be worthy of closer investigation.

Fresenius Medical Care KGaA's current ROCE of 8.5% is lower than its ROCE in the past, which was 12%, 3 years ago. So investors might consider if it has had issues recently. You can see in the image below how Fresenius Medical Care KGaA's ROCE compares to its industry. Click to see more on past growth.

XTRA:FME Past Revenue and Net Income, January 27th 2020

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. 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. Since the future is so important for investors, you should check out our free report on analyst forecasts for Fresenius Medical Care KGaA.

What Are Current Liabilities, And How Do They Affect Fresenius Medical Care KGaA's ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.

Fresenius Medical Care KGaA has total assets of €33b and current liabilities of €7.4b. Therefore its current liabilities are equivalent to approximately 22% of its total assets. Low current liabilities are not boosting the ROCE too much.

The Bottom Line On Fresenius Medical Care KGaA's ROCE

This is good to see, and with a sound ROCE, Fresenius Medical Care KGaA could be worth a closer look. Fresenius Medical Care KGaA looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.

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

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.