This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in CPPGroup Plc (LON:CPP).
If you purchase a CPP share you are effectively becoming a partner with many other shareholders. 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. To understand CPPGroup’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.
What is Return on Capital Employed (ROCE)?
Choosing to invest in CPPGroup comes at the cost of investing in another potentially favourable 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. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if CPPGroup is good at growing investor capital. I have calculated CPPGroup’s ROCE for you below:
ROCE Calculation for CPP
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets - Current Liabilities)
∴ ROCE = UK£4.35m ÷ (UK£60.17m - UK£45.15m) = 28.99%
The calculation above shows that CPP’s earnings were 28.99% of capital employed. Comparing this to a healthy 15% benchmark shows CPPGroup is currently able to return a fantastic amount to owners for the use of their capital, which is a good sign for those who believe this will continue and the company’s management will find good uses for the earnings they create.
Can any of this change?
The encouraging ROCE is good news for CPPGroup investors if the company is able to maintain strong earnings and control their capital needs. But if this doesn’t occur, CPP's ROCE may deteriorate, in which case your money is better invested elsewhere. Because of this, it is important to look beyond the final value of CPP’s ROCE and understand what is happening to the individual components. If you go back three years, you'll find that CPP’s ROCE has increased from 10.10%. With this, the current earnings of UK£4.35m improved from UK£1.09m and capital employed improved as well albeit by a relatively smaller amount, signifying ROCE increased as a result of a greater surge in earnings compared to the business' use of capital.
CPPGroup’s ROCE has increased in the recent past and is currently at a level that makes the company an attractive candidate that is capable of producing solid capital returns, and hence, an attractive return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. Without considering these fundamentals, you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you're interested in diving deeper, take a look at what I've linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for CPP’s future growth? Take a look at our free research report of analyst consensus for CPP’s outlook.
- Valuation: What is CPP worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether CPP is currently mispriced 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.