This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between TPG Telecom Limited (ASX:TPM)’s return fundamentals and stock market performance.
If you purchase a TPM share you are effectively becoming a partner with many other shareholders. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in TPG Telecom, 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).
What is Return on Capital Employed (ROCE)?
Choosing to invest in TPG Telecom comes at the cost of investing in another potentially favourable company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. We’ll look at TPG Telecom’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for TPM
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$553.9m ÷ (AU$5.29b – AU$875.7m) = 12.5%
The calculation above shows that TPM’s earnings were 12.5% of capital employed. This shows TPG Telecom provides an uninspiring capital return that is slightly below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if TPM 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?
TPM 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. Because of this, it is important to look beyond the final value of TPM’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that TPM weakened investor return on capital employed from 20.9%. With this, the current earnings of AU$553.9m improved from AU$269.4m however capital employed rose by a proportionally greater amount due to a rise in total assets , which means that although earnings have increased, TPM requires more capital to produce each A$1 of earnings.
TPM’s investors have experienced a downward trend in ROCE and it is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for TPM’s future growth? Take a look at our free research report of analyst consensus for TPM’s outlook.
- Valuation: What is TPM 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 TPM 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 email@example.com.