Returns On Capital At Telefónica (BME:TEF) Have Hit The Brakes

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 Telefónica (BME:TEF) 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. The formula for this calculation on Telefónica is:

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

0.033 = €2.5b ÷ (€100b - €25b) (Based on the trailing twelve months to September 2024).

Thus, Telefónica has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Telecom industry average of 10%.

Check out our latest analysis for Telefónica

In the above chart we have measured Telefónica'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 analyst report for Telefónica .

So How Is Telefónica's ROCE Trending?

Things have been pretty stable at Telefónica, with its capital employed and returns on that capital staying somewhat the same for the last 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 don't be surprised if Telefónica doesn't end up being a multi-bagger in a few years time. On top of that you'll notice that Telefónica has been paying out a large portion (107%) of earnings in the form of dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.

The Bottom Line On Telefónica's ROCE

In summary, Telefónica isn't compounding its earnings but is generating stable returns on the same amount of capital employed. And in the last five years, the stock has given away 11% 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.

Telefónica does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.

While Telefónica may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.