This article is intended for those of you who are at the beginning of your investing journey and want to better understand how you can grow your money by investing in Treatt plc (LON:TET).
Purchasing Treatt gives you an ownership stake in the company. 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. Therefore, looking at how efficiently Treatt is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
What is Return on Capital Employed (ROCE)?
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. 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 Treatt’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). I have calculated Treatt’s ROCE for you below:
ROCE Calculation for TET
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = UK£14m ÷ (UK£100m – UK£23m) = 18%
As you can see, TET earned £18 from every £100 you invested over the previous twelve months. Comparing this to a healthy 15% benchmark shows Treatt is currently able to return a robust amount to owners for the use of their capital, which is a good sign for those who believe this will continue and the company’s management will find good uses for the earnings they create.
Can any of this change?
Treatt’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Treatt is in a favourable position, but this can change if these factors underperform. Because of this, it is important to look beyond the final value of TET’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that TET boosted investor return on capital employed from 16%. Similarly, the movement in the earnings variable shows a jump from UK£7m to UK£14m 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.
ROCE for TET investors has grown in the last few years and is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This makes the company an attractive place to put your money, but ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation. If you don’t pay attention to these factors you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for TET’s future growth? Take a look at our free research report of analyst consensus for TET’s outlook.
- Valuation: What is TET worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether TET is currently mispriced 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 firstname.lastname@example.org.