Returns On Capital Signal Tricky Times Ahead For XP Power (LON:XPP)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 XP Power (LON:XPP) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on XP Power is:

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

0.10 = UK£38m ÷ (UK£476m - UK£103m) (Based on the trailing twelve months to June 2023).

Thus, XP Power has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Electrical industry average of 12%.

See our latest analysis for XP Power

Above you can see how the current ROCE for XP Power 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 XP Power.

What Can We Tell From XP Power's ROCE Trend?

When we looked at the ROCE trend at XP Power, we didn't gain much confidence. Around five years ago the returns on capital were 19%, but since then they've fallen to 10%. 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.

The Bottom Line On XP Power's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that XP Power is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 56% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 3 warning signs we've spotted with XP Power (including 1 which can't be ignored) .

While XP Power 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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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.