Wolters Kluwer (AMS:WKL) Is Very Good At Capital Allocation

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at Wolters Kluwer's (AMS:WKL) look very promising so lets take a look.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Wolters Kluwer is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.21 = €1.0b ÷ (€8.7b - €3.7b) (Based on the trailing twelve months to June 2020).

Thus, Wolters Kluwer has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Professional Services industry average of 11%.

Check out our latest analysis for Wolters Kluwer

Above you can see how the current ROCE for Wolters Kluwer 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 Wolters Kluwer here for free.

The Trend Of ROCE

Wolters Kluwer's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 59% whilst employing roughly the same amount of capital. 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. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 43% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From Wolters Kluwer's ROCE

To bring it all together, Wolters Kluwer has done well to increase the returns it's generating from its capital employed. Since the stock has returned a staggering 179% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Wolters Kluwer can keep these trends up, it could have a bright future ahead.

Wolters Kluwer does have some risks though, and we've spotted 1 warning sign for Wolters Kluwer that you might be interested in.

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