Returns On Capital At TPG Telecom (ASX:TPG) Paint A Concerning Picture

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating TPG Telecom (ASX:TPG), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on TPG Telecom is:

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

0.015 = AU$254m ÷ (AU$19b - AU$1.6b) (Based on the trailing twelve months to June 2022).

So, TPG Telecom has an ROCE of 1.5%. Ultimately, that's a low return and it under-performs the Telecom industry average of 5.3%.

View 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, you can check out the forecasts from the analysts covering TPG Telecom here for free.

How Are Returns Trending?

When we looked at the ROCE trend at TPG Telecom, we didn't gain much confidence. To be more specific, ROCE has fallen from 12% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, TPG Telecom has decreased its current liabilities to 8.5% of total assets. Considering it used to be 79%, that's a huge drop in that ratio and it would explain the decline in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From TPG Telecom's ROCE

Bringing it all together, while we're somewhat encouraged by TPG Telecom's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 33% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.

Like most companies, TPG Telecom does come with some risks, and we've found 2 warning signs that you should be aware of.

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.