If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it’s a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Rentokil Initial (LON:RTO), it didn’t seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Rentokil Initial:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.12 = UK£294m ÷ (UK£3.4b – UK£916m) (Based on the trailing twelve months to December 2019).
Thus, Rentokil Initial has an ROCE of 12%. In absolute terms, that’s a pretty normal return, and it’s somewhat close to the Commercial Services industry average of 11%.
Above you can see how the current ROCE for Rentokil Initial 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 Rentokil Initial here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Rentokil Initial, we didn’t gain much confidence. To be more specific, ROCE has fallen from 17% over the last five years. 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’s worth keeping an eye on the company’s earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On Rentokil Initial’s ROCE
To conclude, we’ve found that Rentokil Initial is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 305% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn’t get our hopes up too high.
One more thing, we’ve spotted 3 warning signs facing Rentokil Initial that you might find interesting.
While Rentokil Initial isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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