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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Kelly Services (NASDAQ:KELY.A), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Kelly Services:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = US$50m ÷ (US$2.4b - US$797m) (Based on the trailing twelve months to September 2020).
So, Kelly Services has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 9.5%.
Above you can see how the current ROCE for Kelly Services compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Kelly Services here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Kelly Services, we didn't gain much confidence. Around five years ago the returns on capital were 4.5%, but since then they've fallen to 3.1%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.On a related note, Kelly Services has decreased its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Kelly Services' ROCE
We're a bit apprehensive about Kelly Services because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 40% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
If you want to continue researching Kelly Services, you might be interested to know about the 1 warning sign that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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