Some Investors May Be Worried About Primeserv Group's (JSE:PMV) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Primeserv Group (JSE:PMV), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Primeserv Group is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.12 = R22m ÷ (R226m - R39m) (Based on the trailing twelve months to September 2021).

So, Primeserv Group has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Professional Services industry average of 13%.

Check out our latest analysis for Primeserv Group

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Primeserv Group's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Primeserv Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Primeserv Group has done well to pay down its current liabilities to 17% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Primeserv Group's ROCE

Bringing it all together, while we're somewhat encouraged by Primeserv Group's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 269% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we found 2 warning signs for Primeserv Group (1 doesn't sit too well with us) you should be aware of.

While Primeserv Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.