I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in Spotless Group Holdings Limited (ASX:SPO).
Buying Spotless Group Holdings makes you a partial owner of the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. 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. Therefore, looking at how efficiently Spotless Group Holdings is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
ROCE: Explanation and Calculation
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. 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. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Spotless Group Holdings is good at growing investor capital. I have calculated Spotless Group Holdings’s ROCE for you below:
ROCE Calculation for SPO
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$113m ÷ (AU$1.9b – AU$521m) = 8.4%
As you can see, SPO earned A$8.4 from every A$100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Spotless Group Holdings is currently unable to return a satisfactory amount to owners for the use of their capital, which isn’t good for investors who have forgone other potentially solid companies.
A deeper look
Although Spotless Group Holdings is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. Because of this, it is important to look beyond the final value of SPO’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that SPO weakened investor return on capital employed from 13%. In this time, earnings have fallen from AU$206m to AU$113m and capital employed declined as well albeit by a relatively smaller amount, signifying ROCE decreased as a result of a greater fall in earnings compared to the business’ use of capital.
Spotless Group Holdings’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 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 SPO’s future growth? Take a look at our free research report of analyst consensus for SPO’s outlook.
- Valuation: What is SPO 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 SPO 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.