The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Omnicom Group Inc (NYSE:OMC)’s return fundamentals and stock market performance.
Omnicom Group stock represents an ownership share in the company. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. Therefore, looking at how efficiently Omnicom Group is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
See our latest analysis for Omnicom Group
Calculating Return On Capital Employed for OMC
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. We’ll look at Omnicom Group’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. Take a look at the formula box beneath:
ROCE Calculation for OMC
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$1.9b ÷ (US$22.2b – US$12.6b) = 20%
The calculation above shows that OMC’s earnings were 20% of capital employed. Comparing this to a healthy 15% benchmark shows Omnicom Group is currently able to return a robust amount to owners for the use of their capital, which is a good sign for those who believe this will continue and the company’s management will find good uses for the earnings they create.
Does this mean I should invest?
Omnicom Group’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Omnicom Group is in a favourable position, but this can change if these factors underperform. Because of this, it is important to look beyond the final value of OMC’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that OMC’s ROCE has deteriorated from 22%, indicating the company’s capital returns have declined. With this, the current earnings of US$1.9b improved from US$1.8b however capital employed rose by a relatively larger volume because of a hike in the level of total assets , indicating that the previous growth in earnings has not been able to improve ROCE because the company now needs to employ more capital to operate the business.
Next Steps
Despite OMC’s downward trend in ROCE in the recent past, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. It’s important to account for these factors because you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate OMC or other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for OMC’s future growth? Take a look at our free research report of analyst consensus for OMC’s outlook.
- Valuation: What is OMC worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether OMC is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.