Yahoo Finance Investors Met With Slowing Returns on Capital At Compass Group (LON:CPG)
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So, when we ran our eye over Compass Group's (LON:CPG) trend of ROCE, we liked what we saw.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Compass Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = UK£1.9b ÷ (UK£18b - UK£7.6b) (Based on the trailing twelve months to September 2023).
So, Compass Group has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 7.3% generated by the Hospitality industry.
See our latest analysis for Compass Group
Above you can see how the current ROCE for Compass Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Compass Group .
How Are Returns Trending?
While the current returns on capital are decent, they haven't changed much. The company has consistently earned 19% for the last five years, and the capital employed within the business has risen 42% in that time. 19% is a pretty standard return, and it provides some comfort knowing that Compass Group has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
On a separate but related note, it's important to know that Compass Group has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Compass Group's ROCE
To sum it up, Compass Group has simply been reinvesting capital steadily, at those decent rates of return. In light of this, the stock has only gained 37% over the last five years for shareholders who have owned the stock in this period. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.
On a final note, we've found 1 warning sign for Compass Group that we think you should be aware of.
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.
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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.
