Some Investors May Be Worried About Telstra's (ASX:TLS) Returns On Capital

What underlying fundamental trends can indicate that a company might be in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Telstra (ASX:TLS) we aren't filled with optimism, but let's investigate further.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Telstra, this is the formula:

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

0.074 = AU$2.4b ÷ (AU$43b - AU$11b) (Based on the trailing twelve months to December 2021).

Thus, Telstra has an ROCE of 7.4%. In absolute terms, that's a low return, but it's much better than the Telecom industry average of 3.4%.

Check out our latest analysis for Telstra

In the above chart we have measured Telstra's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Telstra.

So How Is Telstra's ROCE Trending?

There is reason to be cautious about Telstra, given the returns are trending downwards. To be more specific, the ROCE was 16% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Telstra becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors must expect better things on the horizon though because the stock has risen 9.7% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 2 warning signs facing Telstra that you might find interesting.

While Telstra may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.