This article is intended for those of you who are at the beginning of your investing journey 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. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. 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. Therefore, looking at how efficiently Navitas 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.
What is Return on Capital Employed (ROCE)?
Choosing to invest in Navitas 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. 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 Navitas is good at growing investor capital. Take a look at the formula box beneath:
ROCE Calculation for NVT
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$104.84m ÷ (AU$850.42m – AU$369.29m) = 21.79%
The calculation above shows that NVT’s earnings were 21.79% of capital employed. Comparing this to a healthy 15% benchmark shows Navitas is currently able to return a strong amount to owners for the use of their capital, which is a good sign for those who believe this will continue and the company’s management will find good uses for the earnings they create.
Does this mean I should invest?
Although Navitas is in a favourable position, you should know that this could change if the company is unable to maintain a strong ROCE above the benchmark, which will depend on the behaviour of the underlying variables (EBT and capital employed). Because of this, it is important to look beyond the final value of NVT’s ROCE and understand what is happening to the individual components. If you go back three years, you’ll find that NVT’s ROCE has decreased from 31.31%. Over the same period, EBT went from AU$119.52m to AU$104.84m 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.
Although Navitas’s ROCE has decreased over the past few years, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. 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. It’s important to account for these factors because you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. Navitas’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- 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? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether NVT is currently mispriced 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.