The Returns On Capital At Sodexo (EPA:SW) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Sodexo (EPA:SW) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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 Sodexo, this is the formula:

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

0.075 = €805m ÷ (€20b - €8.9b) (Based on the trailing twelve months to February 2022).

Thus, Sodexo has an ROCE of 7.5%. In absolute terms, that's a low return, but it's much better than the Hospitality industry average of 2.5%.

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, you can check out the forecasts from the analysts covering Sodexo here for free.

So How Is Sodexo's ROCE Trending?

On the surface, the trend of ROCE at Sodexo doesn't inspire confidence. To be more specific, ROCE has fallen from 15% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, Sodexo has a high ratio of current liabilities to total assets of 45%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Sodexo. These growth trends haven't led to growth returns though, since the stock has fallen 30% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing: We've identified 2 warning signs with Sodexo (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.

While Sodexo 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.