Returns Are Gaining Momentum At TPG Telecom (ASX:TPG)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at TPG Telecom (ASX:TPG) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

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 TPG Telecom:

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

0.014 = AU$237m ÷ (AU$19b - AU$1.5b) (Based on the trailing twelve months to December 2020).

Thus, TPG Telecom has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Telecom industry average of 5.4%.

See our latest analysis for TPG Telecom

In the above chart we have measured TPG Telecom'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 TPG Telecom.

How Are Returns Trending?

We're delighted to see that TPG Telecom is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 1.4% which is a sight for sore eyes. In addition to that, TPG Telecom is employing 256% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a related note, the company's ratio of current liabilities to total assets has decreased to 7.7%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

In Conclusion...

To the delight of most shareholders, TPG Telecom has now broken into profitability. Given the stock has declined 29% in the last year, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for TPG Telecom (of which 1 is concerning!) that you should know about.

While TPG Telecom 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. 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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