This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between Navitas Limited (ASX:NVT)’s return fundamentals and stock market performance.
Purchasing Navitas gives you an ownership stake in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Thus, to understand how your money can grow by investing in Navitas, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
Calculating Return On Capital Employed for NVT
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Navitas’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated Navitas’s ROCE for you below:
ROCE Calculation for NVT
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$44m ÷ (AU$830m – AU$434m) = 13%
The calculation above shows that NVT’s earnings were 13% of capital employed. This shows Navitas provides an uninspiring capital return that is slightly below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if NVT is clever with their reinvestments or dividend payments, investors can still grow their capital but may not see the same compounded performance as other high-returning companies.
What is causing this?
NVT doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you’ll find that NVT’s ROCE has decreased from 39%. In this time, earnings have fallen from AU$131m to AU$44m and capital employed has increased due to a rise in total assets employed , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
Navitas’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, it is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate NVT or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for NVT’s future growth? Take a look at our free research report of analyst consensus for NVT’s outlook.
- Valuation: What is NVT worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether NVT is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.