The Returns At Telecom Plus (LON:TEP) Provide Us With Signs Of What's To Come

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Telecom Plus (LON:TEP) and its ROCE trend, we weren't exactly thrilled.

What is 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. To calculate this metric for Telecom Plus, this is the formula:

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

0.17 = UK£51m ÷ (UK£431m - UK£126m) (Based on the trailing twelve months to September 2020).

So, Telecom Plus has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Integrated Utilities industry average of 4.4% it's much better.

View our latest analysis for Telecom Plus

In the above chart we have measured Telecom Plus' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Telecom Plus here for free.

So How Is Telecom Plus' ROCE Trending?

Things have been pretty stable at Telecom Plus, with its capital employed and returns on that capital staying somewhat the same for the last five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Telecom Plus in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. That probably explains why Telecom Plus has been paying out 105% of its earnings as dividends to shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

The Bottom Line

In summary, Telecom Plus isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 59% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing to note, we've identified 1 warning sign with Telecom Plus and understanding it should be part of your investment process.

While Telecom Plus isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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