Slowing Rates Of Return At Nestlé (VTX:NESN) Leave Little Room For Excitement

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Nestlé (VTX:NESN) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its 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 = CHF16b ÷ (CHF135b - CHF40b) (Based on the trailing twelve months to December 2022).

Thus, Nestlé has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 13% generated by the Food industry.

View our latest analysis for Nestlé

In the above chart we have measured Nestlé'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 Nestlé here for free.

The Trend Of ROCE

There hasn't been much to report for Nestlé's returns and its level of capital employed because both metrics have been steady for the past five years. 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. So unless we see a substantial change at Nestlé in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. That being the case, it makes sense that Nestlé has been paying out 61% of its earnings to its shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

The Bottom Line

In summary, Nestlé isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 47% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we've found 4 warning signs for Nestlé 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.