Should We Be Excited About The Trends Of Returns At QinetiQ Group (LON:QQ.)?

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at QinetiQ Group (LON:QQ.) 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. To calculate this metric for QinetiQ Group, this is the formula:

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

0.12 = UK£131m ÷ (UK£1.5b - UK£396m) (Based on the trailing twelve months to September 2020).

Thus, QinetiQ Group has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Aerospace & Defense industry average of 11%.

See our latest analysis for QinetiQ Group

Above you can see how the current ROCE for QinetiQ Group 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 QinetiQ Group here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at QinetiQ Group doesn't inspire confidence. Around five years ago the returns on capital were 33%, but since then they've fallen to 12%. 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.

On a side note, QinetiQ Group has done well to pay down its current liabilities to 27% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that QinetiQ Group is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 29% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Like most companies, QinetiQ Group does come with some risks, and we've found 1 warning sign that you should be aware of.

While QinetiQ Group 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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