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freenet's (ETR:FNTN) Returns On Capital Not Reflecting Well On The Business

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at freenet (ETR:FNTN), so let's see why.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for freenet:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.054 = €137m ÷ (€3.5b - €960m) (Based on the trailing twelve months to March 2023).

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Thus, freenet has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Wireless Telecom industry average of 8.9%.

Check out our latest analysis for freenet

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In the above chart we have measured freenet's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering freenet here for free.

So How Is freenet's ROCE Trending?

The trend of ROCE at freenet is showing some signs of weakness. The company used to generate 7.1% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 32% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

In Conclusion...

In summary, it's unfortunate that freenet is shrinking its capital base and also generating lower returns. Despite the concerning underlying trends, the stock has actually gained 26% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a separate note, we've found 2 warning signs for freenet you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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