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Here’s why Gelsenwasser AG’s (FRA:WWG) Returns On Capital Matters So Much

Simply Wall St

Today we'll evaluate Gelsenwasser AG (FRA:WWG) to determine whether it could have potential as an investment idea. 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 up, we'll look at what ROCE is and how we calculate it. Next, we'll compare it to others in its industry. And finally, we'll look at how its current liabilities are impacting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. Overall, it is a valuable metric that has its flaws. 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 Gelsenwasser:

0.038 = €53m ÷ (€1.8b - €364m) (Based on the trailing twelve months to December 2018.)

Therefore, Gelsenwasser has an ROCE of 3.8%.

View our latest analysis for Gelsenwasser

Does Gelsenwasser Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. We can see Gelsenwasser's ROCE is meaningfully below the Integrated Utilities industry average of 5.1%. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Separate from how Gelsenwasser stacks up against its industry, its ROCE in absolute terms is mediocre; relative to the returns on government bonds. Readers may find more attractive investment prospects elsewhere.

Our data shows that Gelsenwasser currently has an ROCE of 3.8%, compared to its ROCE of 2.4% 3 years ago. This makes us wonder if the company is improving. You can see in the image below how Gelsenwasser's ROCE compares to its industry. Click to see more on past growth.

DB:WWG Past Revenue and Net Income, August 17th 2019

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. You can check if Gelsenwasser has cyclical profits by looking at this free graph of past earnings, revenue and cash flow.

How Gelsenwasser's Current Liabilities Impact Its ROCE

Current liabilities are short term bills and invoices that need to be paid in 12 months or less. 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 check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Gelsenwasser has total liabilities of €364m and total assets of €1.8b. As a result, its current liabilities are equal to approximately 21% of its total assets. This very reasonable level of current liabilities would not boost the ROCE by much.

Our Take On Gelsenwasser's ROCE

That said, Gelsenwasser's ROCE is mediocre, there may be more attractive investments around. 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.