The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in Whitbread PLC (LON:WTB).
If you purchase a WTB share you are effectively becoming a partner with many other shareholders. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Thus, to understand how your money can grow by investing in Whitbread, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
What is Return on Capital Employed (ROCE)?
Choosing to invest in Whitbread comes at the cost of investing in another potentially favourable company. Accordingly, before you invest you need to assess the capital returns that the company has produced with reference to a certain benchmark to ensure that you are confident in the business’ ability to grow your capital at a level that grants an investment over other companies. To determine Whitbread’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 WTB
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = UK£587m ÷ (UK£5.0b – UK£822m) = 15%
The calculation above shows that WTB’s earnings were 15% of capital employed. This shows Whitbread provides an uninspiring capital return that is slightly below the 15% ROCE that is typically considered to be a strong benchmark. Nevertheless, if WTB is clever with their reinvestments or dividend payments, investors can still grow their capital but may not see the same compounded performance as other high-returning companies.
What is causing this?
WTB doesn’t return an attractive amount on capital, but this will only continue if the company is unable to increase earnings or decrease current capital requirements. 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. Looking at the past 3 year period shows us that WTB boosted investor return on capital employed from 14%. We can see that earnings have increased from UK£465m to UK£587m whilst capital employed also increased but to a smaller extent, which means the company has been able to improve ROCE by driving up earnings relative to the capital invested in the business.
Although Whitbread’s ROCE is currently below the acceptable benchmark, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation to determine whether there is potential for return by focusing our attention elsewhere. Whitbread’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for WTB’s future growth? Take a look at our free research report of analyst consensus for WTB’s outlook.
- Valuation: What is WTB 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 WTB is currently undervalued by the market.
- 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 email@example.com.