Compass Group (LON:CPG) Might Be Having Difficulty Using Its Capital Effectively

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Compass Group (LON:CPG) and its ROCE trend, we weren't exactly thrilled.

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 Compass Group is:

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

0.11 = UK£1.1b ÷ (UK£15b - UK£5.6b) (Based on the trailing twelve months to March 2022).

Thus, Compass Group has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 4.2% it's much better.

View our latest analysis for Compass Group

In the above chart we have measured Compass Group'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 Compass Group here for free.

What Does the ROCE Trend For Compass Group Tell Us?

On the surface, the trend of ROCE at Compass Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 23% five years ago. 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 Key Takeaway

While returns have fallen for Compass Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends are starting to be recognized by investors since the stock has delivered a 20% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you're still interested in Compass Group it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.