Shareholders Should Look Hard At FNM S.p.A.’s (BIT:FNM) 3.8% Return On Capital

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Today we'll look at FNM S.p.A. (BIT:FNM) and reflect on its potential as an investment. 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.

Firstly, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Finally, we'll look at how its current liabilities affect its ROCE.

Understanding Return On Capital Employed (ROCE)

ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. 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'.

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 FNM:

0.038 = €26m ÷ (€933m - €251m) (Based on the trailing twelve months to December 2018.)

Therefore, FNM has an ROCE of 3.8%.

View our latest analysis for FNM

Does FNM Have A Good ROCE?

ROCE is commonly used for comparing the performance of similar businesses. We can see FNM's ROCE is meaningfully below the Transportation industry average of 9.1%. This could be seen as a negative, as it suggests some competitors may be employing their capital more efficiently. Independently of how FNM compares to its industry, its ROCE in absolute terms is low; especially compared to the ~2.9% available in government bonds. Readers may wish to look for more rewarding investments.

BIT:FNM Past Revenue and Net Income, June 13th 2019
BIT:FNM Past Revenue and Net Income, June 13th 2019

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is only a point-in-time measure. If FNM is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

Do FNM's Current Liabilities Skew 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 counter this, investors can check if a company has high current liabilities relative to total assets.

FNM has total liabilities of €251m and total assets of €933m. As a result, its current liabilities are equal to approximately 27% of its total assets. This is a modest level of current liabilities, which will have a limited impact on the ROCE.

What We Can Learn From FNM's ROCE

That's not a bad thing, however FNM has a weak ROCE and may not be an attractive investment. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

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.

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