What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. With that in mind, we've noticed some promising trends at Vodafone Group (LON:VOD) so let's look a bit deeper.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Vodafone Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = €4.4b ÷ (€168b - €34b) (Based on the trailing twelve months to March 2020).
Thus, Vodafone Group has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Wireless Telecom industry average of 10%.
In the above chart we have a measured Vodafone Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vodafone Group.
The Trend Of ROCE
While there are companies with higher returns on capital out there, we still find the trend at Vodafone Group promising. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 94% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
The Key Takeaway
In summary, we're delighted to see that Vodafone Group has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Given the stock has declined 35% in the last five years, there could be a chance of a good investment here if the valuation makes sense. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to know some of the risks facing Vodafone Group we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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