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TPG Telecom (ASX:TPG) Could Be Struggling To Allocate Capital

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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at TPG Telecom (ASX:TPG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on TPG Telecom is:

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

0.017 = AU$291m ÷ (AU$19b - AU$1.7b) (Based on the trailing twelve months to December 2021).

So, TPG Telecom has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Telecom industry average of 3.4%.

Check out our latest analysis for TPG Telecom

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Above you can see how the current ROCE for TPG Telecom 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 report for TPG Telecom.

What Can We Tell From TPG Telecom's ROCE Trend?

In terms of TPG Telecom's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 1.7% from 7.2% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, TPG Telecom has decreased its current liabilities to 8.7% of total assets. Since the ratio used to be 81%, that's a significant reduction and it no doubt explains the drop in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for TPG Telecom. And the stock has followed suit returning a meaningful 13% to shareholders over the last year. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you want to continue researching TPG Telecom, you might be interested to know about the 2 warning signs that our analysis has discovered.

While TPG Telecom may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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