Slowing Rates Of Return At Vector (NZSE:VCT) Leave Little Room For Excitement

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Having said that, from a first glance at Vector (NZSE:VCT) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Vector is:

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

0.058 = NZ$328m ÷ (NZ$6.4b - NZ$748m) (Based on the trailing twelve months to December 2020).

Therefore, Vector has an ROCE of 5.8%. In absolute terms, that's a low return, but it's much better than the Integrated Utilities industry average of 4.7%.

Check out our latest analysis for Vector

In the above chart we have measured Vector's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Vector's ROCE Trend?

Over the past five years, Vector's ROCE and capital employed have both remained mostly flat. 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 Vector to be a multi-bagger going forward. That probably explains why Vector has been paying out 122% 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.

What We Can Learn From Vector's ROCE

In summary, Vector 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 57% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a separate note, we've found 2 warning signs for Vector you'll probably want to know about.

While Vector 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. 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.
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