Investors Could Be Concerned With Compass Group's (LON:CPG) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Compass Group (LON:CPG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Compass Group, this is the formula:

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

0.0012 = UK£11m ÷ (UK£14b - UK£4.6b) (Based on the trailing twelve months to March 2021).

Thus, Compass Group has an ROCE of 0.1%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 15%.

View our latest analysis for Compass Group

Above you can see how the current ROCE for Compass Group 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 Compass Group here for free.

What Can We Tell From Compass Group's ROCE Trend?

We weren't thrilled with the trend because Compass Group's ROCE has reduced by 100% over the last five years, while the business employed 75% more capital. Usually this isn't ideal, but given Compass Group conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Compass Group probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a related note, Compass Group has decreased its current liabilities to 33% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Compass Group have fallen, meanwhile the business is employing more capital than it was five years ago. In spite of that, the stock has delivered a 3.5% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 1 warning sign facing Compass Group that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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