This article is intended for those of you who are at the beginning of your investing journey and looking to gauge the potential return on investment in Treatt plc (LON:TET).
Purchasing Treatt gives you an ownership stake in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. Your return is tied to TET’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Thus, to understand how your money can grow by investing in Treatt, 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).See our latest analysis for Treatt
What is Return on Capital Employed (ROCE)?
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. 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. We’ll look at Treatt’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. 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£13.87m ÷ (UK£100.17m – UK£22.94m) = 17.96%
The calculation above shows that TET’s earnings were 17.96% of capital employed. This shows Treatt provides a favourable return to capital holders, which beats the 15% ROCE that is typically considered to be a strong benchmark. As a result, if TET is clever with their reinvestments or dividend payments, investors can grow their capital at an attractive rate over time.
A deeper look
TET is efficient with the use of capital, but this is only the case if TET continues to maintain the presently healthy ROCE, which will change if the company either earns less or requires more capital to create earnings. Therefore, investors need to be confident in the trend of the inputs in the formula above, so that Treatt will continue the solid returns. Looking at the past 3 year period shows us that TET boosted investor return on capital employed from 15.93%. Similarly, the movement in the earnings variable shows a jump from UK£7.05m to UK£13.87m whilst the amount of capital employed also grew but by a proportionally lesser volume, which suggests the larger ROCE is due to a growth in earnings relative to capital requirements.
TET’s investors have enjoyed an upward trend in ROCE and it is currently at a level that makes the company an attractive candidate that is capable of producing solid capital returns, and hence, an attractive return on investment. As an investor this is the type of situation you look for, but return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and management ability. It’s important to account for these factors because you cannot be sure if this trend will continue or reverse due to reasons that cannot be seen by looking in the past. 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.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Treatt’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- 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.