Capital Allocation Trends At Compass Group (LON:CPG) Aren't Ideal
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Compass Group (LON:CPG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
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 Compass Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = UK£2.0b ÷ (UK£17b - UK£6.4b) (Based on the trailing twelve months to March 2023).
So, Compass Group has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 7.0% generated by the Hospitality industry.
Check out our latest analysis for Compass Group
Above you can see how the current ROCE for Compass Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Compass Group's ROCE Trend?
In terms of Compass Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 25%, but since then they've fallen to 18%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Compass Group's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Compass Group. In light of this, the stock has only gained 32% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.
On a separate note, we've found 1 warning sign for Compass Group you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
