VMware Inc (NYSE:VMW): A Look At Return On Capital

This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in VMware Inc (NYSE:VMW).

Purchasing VMware gives you an ownership stake in the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. To understand VMware’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.

Check out our latest analysis for VMware

What is Return on Capital Employed (ROCE)?

When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business' ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if VMware is good at growing investor capital. I have calculated VMware’s ROCE for you below:

VMW’s 10.4% ROCE means that for every $100 you invest, the company creates $10.4. A good ROCE hurdle you should aim for in your investments is 15%, which VMW has just fallen short of, meaning the company creates an unideal amount of earnings from capital employed.

A deeper look

The underperforming ROCE is not ideal for VMware investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, VMW's ROCE may increase, in which case your portfolio could benefit from holding the company. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you'll find that VMW’s ROCE has decreased from 11.7%. Conversely, the movement in the earnings variable shows a jump from US$1.23b to US$1.91b albeit capital employed has grown by a relatively larger volume due to a hike in the level of total assets , which suggests investor's ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.

Next Steps

ROCE for VMW investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable 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. 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 VMW or move on to other alternatives.

1. Future Outlook: What are well-informed industry analysts predicting for VMW’s future growth? Take a look at our free research report of analyst consensus for VMW’s outlook.
2. Valuation: What is VMW worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether VMW is currently undervalued by the market.
3. 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.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article 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.