Telstra's (ASX:TLS) Returns On Capital Not Reflecting Well On The Business

What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Telstra (ASX:TLS), the trends above didn't look too great.

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. 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 5.9%.

View our latest analysis for Telstra

Above you can see how the current ROCE for Telstra compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Telstra here for free.

So How Is Telstra's ROCE Trending?

We are a bit worried about the trend of returns on capital at Telstra. About five years ago, returns on capital were 17%, however they're now substantially lower than that as we saw above. 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. 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 On Telstra's ROCE

In summary, it's unfortunate that Telstra is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 1.0% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing, we've spotted 3 warning signs facing Telstra that you might find interesting.

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.
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