What are the early trends we should look for to identify a stock that could 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Elisa Oyj (HEL:ELISA) looks decent, right now, so lets see what the trend of returns can tell us.
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. Analysts use this formula to calculate it for Elisa Oyj:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = €414m ÷ (€3.0b - €656m) (Based on the trailing twelve months to September 2020).
So, Elisa Oyj has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Telecom industry average of 8.1% it's much better.
In the above chart we have measured Elisa Oyj'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 Elisa Oyj here for free.
How Are Returns Trending?
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 47% more capital in the last five years, and the returns on that capital have remained stable at 17%. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line
The main thing to remember is that Elisa Oyj has proven its ability to continually reinvest at respectable rates of return. Therefore it's no surprise that shareholders have earned a respectable 65% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
If you want to know some of the risks facing Elisa Oyj we've found 2 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
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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