If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Pepkor Holdings (JSE:PPH) so let's look a bit deeper.
What is 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. To calculate this metric for Pepkor Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.088 = R7.2b ÷ (R100b - R19b) (Based on the trailing twelve months to March 2021).
Therefore, Pepkor Holdings has an ROCE of 8.8%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 22%.
In the above chart we have measured Pepkor Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Pepkor Holdings.
What Does the ROCE Trend For Pepkor Holdings Tell Us?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 8.8%. The amount of capital employed has increased too, by 36%. So we're very much inspired by what we're seeing at Pepkor Holdings thanks to its ability to profitably reinvest capital.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 19%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Pepkor Holdings has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
Our Take On Pepkor Holdings' ROCE
In summary, it's great to see that Pepkor Holdings can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with a respectable 38% awarded to those who held the stock over the last three years, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
While Pepkor Holdings isn't earning the highest return, check out this free list of companies that are 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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