This article is intended for those of you who are at the beginning of your investing journey and want to begin learning the link between Versum Materials Inc (NYSE:VSM)’s return fundamentals and stock market performance.
Versum Materials 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. Your return is tied to VSM’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand Versum Materials’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
Versum Materials’s Return On Capital Employed
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. 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 Versum Materials’s returns by computing return on capital employed, which will tell us what the company can generate from the money spent in operations. I have calculated Versum Materials’s ROCE for you below:
ROCE Calculation for VSM
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$321.3m ÷ (US$1.41b – US$162.0m) = 25.8%
VSM’s 25.8% ROCE means that for every $100 you invest, the company creates $25.8. This shows Versum Materials provides a great return on capital employed that is well above the 15% ROCE that is typically considered to be a strong benchmark. As a result, if VSM is clever with their reinvestments or dividend payments, investors can grow their capital at an enviable rate over time.
A deeper look
Versum Materials’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Versum Materials is in a favourable position, but this can change if these factors underperform. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Three years ago, VSM’s ROCE was 26.9%, which means the company’s capital returns have worsened. Conversely, the movement in the earnings variable shows a jump from US$244.5m to US$321.3m albeit capital employed has grown by a proportionally greater amount as a result of a hike in the level of total assets , which means that although earnings have increased, VSM requires more capital to produce each $1 of earnings.
Despite VSM’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. It is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. Without considering these fundamentals, 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 VSM or other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for VSM’s future growth? Take a look at our free research report of analyst consensus for VSM’s outlook.
- Valuation: What is VSM 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 VSM 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 email@example.com.