If you are looking for a multi-bagger, there are a few things to look out for. In a perfect world, we would like a business to invest more capital in their business, and ideally the returns from that capital increase as well. Ultimately, this demonstrates that this is a company that is reinvesting its profits at increasing rates of return. However, after briefly reviewing the numbers, we don’t think Compass group (LON: CPG) has the makings of a multi-bagger in the future, but let’s see why it may be.
Understanding Return on Capital Employed (ROCE)
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. To calculate this metric for Compass Group, here is the formula:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.0012 = £ 11 million (£ 14 billion – £ 4.6 billion) (Based on the last twelve months up to March 2021).
So, Compass Group has a ROCE of 0.1%. In absolute terms, this is a low return and it is also below the hospitality industry average of 15%.
Check out our latest analysis for Compass Group
Above you can see how Compass Group’s current ROCE compares to its previous returns on capital, but there is little you can say about the past. If you like, you can view the analysts’ forecasts covering Compass Group here for free.
What can we say about the Compass Group ROCE trend?
We weren’t thrilled with the trend as Compass Group’s ROCE declined 100% over the past five years, while the company employed 75% more capital. This is usually not ideal, but given that Compass Group conducted a fundraiser before its last earnings announcement, it likely would have contributed, at least partially, to the increase in the capital employed figure. Compass Group has probably not yet received a full year of profit from the new funds it has raised, so these numbers should be taken with a grain of salt.
On a related note, Compass Group reduced its current liabilities to 33% of total assets. This could partly explain the drop in ROCE. In addition, it can reduce some aspects of the risk to the business, as the company’s suppliers or short-term creditors are now less funding its operations. Since the company essentially finances a larger portion of its operations with its own money, you could argue that this has made the company less efficient at generating ROCE.
Based on the above analysis, we find it rather worrying that Compass Group returns on capital and sales have plummeted, despite the company employing more capital than five years ago. Despite this, the stock delivered a 3.5% return to shareholders who have owned it over the past five years. Either way, we don’t like trends as they are and if they persist we think you might find better investments elsewhere.
One more thing, we spotted 1 warning sign facing Compass Group that you might find interesting.
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
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