Returns On Capital Signal Tricky Times Ahead For Sodexo (EPA:SW)

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Sodexo (EPA:SW), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Sodexo:

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

0.014 = €126m ÷ (€18b - €8.9b) (Based on the trailing twelve months to February 2021).

So, Sodexo has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 6.7%.

Check out our latest analysis for Sodexo

Above you can see how the current ROCE for Sodexo 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 Sodexo.

What Does the ROCE Trend For Sodexo Tell Us?

When we looked at the ROCE trend at Sodexo, we didn't gain much confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 1.4%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

Another thing to note, Sodexo has a high ratio of current liabilities to total assets of 49%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Sodexo have fallen, meanwhile the business is employing more capital than it was five years ago. Investors must expect better things on the horizon though because the stock has risen 7.2% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Like most companies, Sodexo does come with some risks, and we've found 1 warning sign that you should be aware of.

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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