The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Chemring Group plc (LON:CHG).
Purchasing Chemring Group gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently Chemring Group is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
What is Return on Capital Employed (ROCE)?
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. 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 Chemring Group’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). I have calculated Chemring Group’s ROCE for you below:
ROCE Calculation for CHG
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = UK£38m ÷ (UK£620m – UK£103m) = 9.1%
As you can see, CHG earned £9.1 from every £100 you invested over the previous twelve months. A good ROCE hurdle you should aim for in your investments is 15%, which CHG has failed to reach, meaning the company creates an unimpressive amount of earnings from capital employed.
A deeper look
Although Chemring Group is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Three years ago, CHG’s ROCE was 1.6%, which means the company’s capital returns have improved. With this, the current earnings of UK£38m improved from UK£14m and capital employed fell due to a fall in total assets and increase in current liabilities (more borrowed money) , which means the company has been able to improve ROCE by growing earnings and simultaneously putting less capital to work.
Despite CHG’s current ROCE remains at an unattractive level, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation to determine whether there is potential for return by focusing our attention elsewhere. Chemring Group’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 CHG’s future growth? Take a look at our free research report of analyst consensus for CHG’s outlook.
- Valuation: What is CHG 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 CHG 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 firstname.lastname@example.org.