What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Greggs (LON:GRG) and its ROCE trend, we weren't exactly thrilled.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Greggs, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = UK£115m ÷ (UK£808m - UK£169m) (Based on the trailing twelve months to July 2021).
Therefore, Greggs has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 4.8% generated by the Hospitality industry.
In the above chart we have measured Greggs' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Greggs.
How Are Returns Trending?
When we looked at the ROCE trend at Greggs, we didn't gain much confidence. Around five years ago the returns on capital were 28%, but since then they've fallen to 18%. 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
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Greggs. And long term investors must be optimistic going forward because the stock has returned a huge 265% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
While Greggs doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
While Greggs isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
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