I am writing today to help inform people who are new to the stock market and want to begin learning the link between Savencia SA (EPA:SAVE)’s return fundamentals and stock market performance.
Purchasing Savencia gives you an ownership stake in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand Savencia’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
Calculating Return On Capital Employed for SAVE
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine Savencia’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:
ROCE Calculation for SAVE
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = €130m ÷ (€3.7b – €1.8b) = 7.7%
SAVE’s 7.7% ROCE means that for every €100 you invest, the company creates €7.7. A good ROCE hurdle you should aim for in your investments is 15%, which SAVE has failed to reach, meaning the company creates an unimpressive amount of earnings from capital employed.
Why is this the case?
The underperforming ROCE is not ideal for Savencia investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, SAVE’s ROCE may increase, in which case your portfolio could benefit from holding the company. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Looking three years in the past, it is evident that SAVE’s ROCE has deteriorated from 8.0%, indicating the company’s capital returns have declined. We can see that earnings have actually increased from €83m to €130m but capital employed has improved by a relatively larger volume as a result of a hike in the level of total assets , which means that although earnings have increased, SAVE requires more capital to produce each €1 of earnings.
Savencia’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Savencia’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for SAVE’s future growth? Take a look at our free research report of analyst consensus for SAVE’s outlook.
- Valuation: What is SAVE worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether SAVE is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.