Capital Allocation Trends At PZ Cussons (LON:PZC) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Having said that, from a first glance at PZ Cussons (LON:PZC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on PZ Cussons is:

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

0.066 = UK£52m ÷ (UK£988m - UK£210m) (Based on the trailing twelve months to May 2023).

So, PZ Cussons has an ROCE of 6.6%. In absolute terms, that's a low return and it also under-performs the Personal Products industry average of 8.6%.

Check out our latest analysis for PZ Cussons

In the above chart we have measured PZ Cussons' 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 PZ Cussons.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at PZ Cussons doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, PZ Cussons has decreased its current liabilities to 21% 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.

Our Take On PZ Cussons' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that PZ Cussons is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 34% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Like most companies, PZ Cussons does come with some risks, and we've found 2 warning signs that you should be aware of.

While PZ Cussons may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.