What Do The Returns On Capital At Nestlé (VTX:NESN) Tell Us?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Nestlé, this is the formula:

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

0.19 = CHF15b ÷ (CHF119b - CHF38b) (Based on the trailing twelve months to June 2020).

So, Nestlé has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 9.7% it's much better.

See 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 to see what analysts are forecasting going forward, you should check out our free report for Nestlé.

What Does the ROCE Trend For Nestlé Tell Us?

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. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. 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 60% 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 Key Takeaway

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 57% 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.

On a final note, we've found 1 warning sign for Nestlé that we think you should be aware of.

While Nestlé isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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