What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Nestlé (VTX:NESN) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
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 Nestlé:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = CHF15b ÷ (CHF138b - CHF44b) (Based on the trailing twelve months to June 2022).
Therefore, Nestlé has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 11% generated by the Food industry.
View our latest analysis for Nestlé
Above you can see how the current ROCE for Nestlé compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Nestlé.
What Can We Tell From Nestlé's ROCE Trend?
Over the past five years, Nestlé's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Nestlé to be a multi-bagger going forward. That being the case, it makes sense that Nestlé has been paying out 60% of its earnings to its shareholders. Most shareholders probably know this and own the stock for its dividend.
In Conclusion...
In a nutshell, Nestlé has been trudging along with the same returns from the same amount of capital over the last five years. Since the stock has gained an impressive 62% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing to note, we've identified 2 warning signs with Nestlé and understanding them should be part of your investment process.
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.
About SWX:NESN
Established dividend payer and good value.