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

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Sodexo (EPA:SW) 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 Sodexo is:

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

0.11 = €1.1b ÷ (€21b - €9.8b) (Based on the trailing twelve months to February 2023).

Therefore, Sodexo has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.3% generated by the Hospitality industry.

See 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.

The Trend Of ROCE

When we looked at the ROCE trend at Sodexo, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that Sodexo has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Sodexo is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 11% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Sodexo (of which 1 doesn't sit too well with us!) that you should know about.

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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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.