I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Village Roadshow Limited (ASX:VRL).
If you purchase a VRL share you are effectively becoming a partner with many other shareholders. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. 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 Village Roadshow, 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).
Village Roadshow’s Return On Capital Employed
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business’ ability to grow your capital at a level that grants an investment over other companies. 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 Village Roadshow is good at growing investor capital. I have calculated Village Roadshow’s ROCE for you below:
ROCE Calculation for VRL
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = AU$7.38m ÷ (AU$1.52b – AU$358.43m) = 0.63%
VRL’s 0.63% ROCE means that for every A$100 you invest, the company creates A$0.6. This shows Village Roadshow provides an unsatisfying capital return that is well below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if VRL is clever with their reinvestments or dividend payments, investors can still grow their capital although to a poor extent.
Then why have investors invested?
The underperforming ROCE is not ideal for Village Roadshow investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, VRL’s ROCE may increase, in which case your portfolio could benefit from holding the company. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Three years ago, VRL’s ROCE was 6.45%, which means the company’s capital returns have worsened. The movement in the earnings variable over this time shows a fall from AU$70.25m to AU$7.38m whilst capital employed has increased due to a hike in the level of total assets and decrease in current liabilities (less borrowed money) , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.
ROCE for VRL investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators 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 VRL’s future growth? Take a look at our free research report of analyst consensus for VRL’s outlook.
- Valuation: What is VRL 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 VRL 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 pass 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.