Slowing Rates Of Return At Pirelli & C (BIT:PIRC) Leave Little Room For Excitement

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Pirelli & C (BIT:PIRC), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Pirelli & C:

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

0.06 = €580m ÷ (€13b - €3.2b) (Based on the trailing twelve months to September 2021).

Therefore, Pirelli & C has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 9.6%.

See our latest analysis for Pirelli & C

In the above chart we have measured Pirelli & C's 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 Pirelli & C.

So How Is Pirelli & C's ROCE Trending?

There hasn't been much to report for Pirelli & C's returns and its level of capital employed because both metrics have been steady for the past 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. With that in mind, unless investment picks up again in the future, we wouldn't expect Pirelli & C to be a multi-bagger going forward. This probably explains why Pirelli & C is paying out 36% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.

In Conclusion...

In summary, Pirelli & C isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Unsurprisingly, the stock has only gained 13% over the last three years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 2 warning signs facing Pirelli & C that you might find interesting.

While Pirelli & C 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.