What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at TPG Telecom (ASX:TPG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)
0.019 = AU$344m ÷ (AU$19b - AU$1.3b) (Based on the trailing twelve months to June 2021).
Thus, TPG Telecom has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Telecom industry average of 4.8%.
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, you can check out the forecasts from the analysts covering TPG Telecom here for free.
What The Trend Of ROCE Can Tell Us
In terms of TPG Telecom's historical ROCE trend, it doesn't exactly demand attention. Over the past five years, ROCE has remained relatively flat at around 1.9% and the business has deployed 282% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
On a side note, TPG Telecom has done well to reduce current liabilities to 6.7% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
The Key Takeaway
In summary, TPG Telecom has simply been reinvesting capital and generating the same low rate of return as before. Since the stock has declined 11% over the last year, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
On a final note, we've found 2 warning signs for TPG Telecom that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.