Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Vector Group (NYSE:VGR) looks great, so lets see what the trend can tell us.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Vector Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.37 = US$427m ÷ (US$1.5b - US$388m) (Based on the trailing twelve months to September 2021).
So, Vector Group has an ROCE of 37%. That's a fantastic return and not only that, it outpaces the average of 17% earned by companies in a similar industry.
Above you can see how the current ROCE for Vector Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vector Group.
What The Trend Of ROCE Can Tell Us
Vector Group is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 64% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 25% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
Our Take On Vector Group's ROCE
To bring it all together, Vector Group has done well to increase the returns it's generating from its capital employed. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 38% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
Vector Group does have some risks, we noticed 4 warning signs (and 2 which are significant) we think you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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.
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