FIH group plc (LON:FIH): Why Return On Capital Employed Is Important

I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in FIH group plc (LON:FIH).

FIH group stock represents an ownership share in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand FIH group’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.

FIH group’s Return On Capital Employed

You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. To determine FIH group’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:

ROCE Calculation for FIH

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = UK£3m ÷ (UK£66m – UK£12m) = 5.9%

FIH’s 5.9% ROCE means that for every £100 you invest, the company creates £5.9. A good ROCE hurdle you should aim for in your investments is 15%, which FIH has failed to reach, meaning the company creates an unimpressive amount of earnings from capital employed.

What is causing this?

The underperforming ROCE is not ideal for FIH group investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, FIH’s ROCE may increase, in which case your portfolio could benefit from holding the company. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Three years ago, FIH’s ROCE was 7.2%, which means the company’s capital returns have worsened. In this time, earnings have fallen from UK£3m to UK£3m and capital employed has increased due to an increase in total assets employed , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.

Next Steps

FIH group’s ROCE has decreased in the recent past and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. 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.

1. Future Outlook: What are well-informed industry analysts predicting for FIH’s future growth? Take a look at our free research report of analyst consensus for FIH’s outlook.
2. Valuation: What is FIH worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether FIH is currently undervalued by the market.
3. 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 editorial-team@simplywallst.com.