If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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 indicates the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Telstra (ASX:TLS), so let's see why.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Telstra:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = AU$2.1b ÷ (AU$43b - AU$10b) (Based on the trailing twelve months to June 2021).
Therefore, Telstra has an ROCE of 6.6%. In absolute terms, that's a low return but it's around the Telecom industry average of 5.7%.
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.
What Can We Tell From Telstra's ROCE Trend?
In terms of Telstra's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 17% 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Telstra to turn into a multi-bagger.
The Bottom Line On Telstra's ROCE
In summary, it's unfortunate that Telstra is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 7.7% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
Telstra does have some risks though, and we've spotted 3 warning signs for Telstra that you might be interested in.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.