Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Although, when we looked at Charter Communications (NASDAQ:CHTR), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
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 Charter Communications, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = US$7.3b ÷ (US$145b - US$9.1b) (Based on the trailing twelve months to June 2020).
Thus, Charter Communications has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Media industry average of 9.6%.
Above you can see how the current ROCE for Charter Communications compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Charter Communications here for free.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Charter Communications doesn't inspire confidence. Around five years ago the returns on capital were 7.2%, but since then they've fallen to 5.4%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line On Charter Communications' ROCE
In summary, Charter Communications is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park delivering a 202% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Charter Communications does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should know about.
While Charter Communications 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.
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. 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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