What Do The Returns On Capital At Sodexo (EPA:SW) Tell Us?

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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)?

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)

0.056 = €537m ÷ (€17b - €7.7b) (Based on the trailing twelve months to August 2020).

So, Sodexo has an ROCE of 5.6%. On its own, that's a low figure but it's around the 5.3% average generated by the Hospitality industry.

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.

The Trend Of ROCE

When we looked at the ROCE trend at Sodexo, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.6% from 15% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

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.

In Conclusion...

We're a bit apprehensive about Sodexo because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 15% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing, we've spotted 1 warning sign facing Sodexo that you might find interesting.

While Sodexo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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