If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, the ROCE of Spark New Zealand (NZSE:SPK) looks decent, right now, so lets see what the trend of returns can tell us.
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 Spark New Zealand, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = NZ$609m ÷ (NZ$4.2b - NZ$800m) (Based on the trailing twelve months to December 2020).
So, Spark New Zealand has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Telecom industry.
In the above chart we have measured Spark New Zealand's 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 Spark New Zealand here for free.
The Trend Of ROCE
While the current returns on capital are decent, they haven't changed much. The company has employed 34% more capital in the last five years, and the returns on that capital have remained stable at 18%. 18% is a pretty standard return, and it provides some comfort knowing that Spark New Zealand has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line On Spark New Zealand's ROCE
To sum it up, Spark New Zealand has simply been reinvesting capital steadily, at those decent rates of return. Therefore it's no surprise that shareholders have earned a respectable 71% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Spark New Zealand does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...
While Spark New Zealand 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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