This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Kingfisher plc (LON:KGF).
Kingfisher stock represents an ownership share 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. 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 Kingfisher, 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).
ROCE: Explanation and Calculation
You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Kingfisher is good at growing investor capital. I have calculated Kingfisher’s ROCE for you below:
ROCE Calculation for KGF
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = UK£685.0m ÷ (UK£10.35b – UK£3.05b) = 9.4%
The calculation above shows that KGF’s earnings were 9.4% of capital employed. This makes Kingfisher unattractive when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital will be able to compound over time, but not to the extent investors should be aiming for.
Why is this the case?
KGF 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 three years in the past, it is evident that KGF’s ROCE has deteriorated from 9.4%, indicating the company’s capital returns have declined. Over the same period, EBT went from UK£656.0m to UK£685.0m but capital employed has grown by a relatively larger volume because of a rise in total assets , indicating that the previous growth in earnings has not been able to improve ROCE because the company now needs to employ more capital to operate the business.
KGF’s investors have experienced a downward trend in ROCE and it is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. 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. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate KGF or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for KGF’s future growth? Take a look at our free research report of analyst consensus for KGF’s outlook.
- Valuation: What is KGF 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 KGF 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 firstname.lastname@example.org.