Returns On Capital Signal Tricky Times Ahead For CPPGroup (LON:CPP)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at CPPGroup (LON:CPP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on CPPGroup is:

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

0.19 = UK£4.3m ÷ (UK£57m - UK£34m) (Based on the trailing twelve months to December 2020).

Thus, CPPGroup has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 10% generated by the Commercial Services industry.

View our latest analysis for CPPGroup

In the above chart we have measured CPPGroup's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering CPPGroup here for free.

How Are Returns Trending?

When we looked at the ROCE trend at CPPGroup, we didn't gain much confidence. Around five years ago the returns on capital were 54%, but since then they've fallen to 19%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, CPPGroup has decreased its current liabilities to 60% of total assets. So we could link some of this to the decrease in ROCE. 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. Keep in mind 60% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On CPPGroup's ROCE

In summary, CPPGroup is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 37% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think CPPGroup has the makings of a multi-bagger.

One more thing: We've identified 2 warning signs with CPPGroup (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. 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.
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