If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Although, when we looked at PageGroup (LON:PAGE), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on PageGroup is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = UK£17m ÷ (UK£630m - UK£229m) (Based on the trailing twelve months to December 2020).
Thus, PageGroup has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 12%.
Above you can see how the current ROCE for PageGroup 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 PageGroup here for free.
How Are Returns Trending?
In terms of PageGroup's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 39%, but since then they've fallen to 4.2%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
In summary, we're somewhat concerned by PageGroup's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 56% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
PageGroup could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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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